Corporate Social Responsibility (CSR) – Activities, Reporting & Accounting

  • CSR CONCEPTS

Corporate Responsibility is the continuing commitment by business to behave ethically and a positive continuity towards social and economic development at large. It is the contribution of the corporate sector for philanthropic causes like education, health, water, environment and community welfare. Corporate responsibility evokes from good governance.

Good Governance covers moral values, powers, dedication, self-management, sagacity, self-conduct, synergy, simplicity and honesty.

Corporate Governance is the system by which the corporate entities are directed and controlled. It encompasses the entire mechanics of the functioning of a company and attempts to put in place a system of checks and balances between the shareholders, directors, auditors and the management.

Values are the soul of a company that defines its character and personality. Values guide, shape and influence the behavior and actions of the board of directors. The core values of a business enterprise are shaped around the belief that enterprises exist to serve society.

At the heart of the value system is an unwavering commitment to integrity, ethical conduct, meritocracy, teamwork and abiding concern for stakeholders.

  • GLOBAL CODES & STANDARDS ON CSR

1. United Nations Global Compact: The United Nations Global Compact is a United Nations initiative to encourage businesses worldwide to adopt sustainable and socially responsible policies, and to report on their implementation.

2. Global Reporting Initiative (GRI): GRI is an international independent organization that helps businesses, governments and other organizations understand and communicate the impact of business on critical sustainability issues such as climate change, human rights, corruption and many others.

3. ISO 14000: ISO 14000 is a series of environmental management standards developed and published by the International Organization for Standardization ( ISO ) for organizations. The ISO 14000 standards provide a guideline or framework for organizations that need to systematize and improve their environmental management efforts.

4. ISO 26000: ISO 26000:2010 is intended to assist organizations in contributing to sustainable development.

5. Organisation for Economic Co-operation and Development (OECD): The mission of the OECD is to promote policies that will improve the economic and social well-being of people around the world.

6. International Labour Organisation Conventions: The International Labour Organization Conventions aim to improve the labour standards of people around the world.

7. National voluntary guidelines on social, environmental and economic responsibilities of business, 2011: These guidelines released in July 2011 by the Ministry Of Corporate Affairs, Government Of India, provide a robust framework that may be adopted voluntarily by companies to address interests of various stakeholders, including employees, customers and investors. Accordingly, the SEBI has mandated listed companies to report on Environmental, Social and Governance (ESG) initiatives undertaken by them.

8. Section 135 of the Companies Act, 2013 (the Act):

Section 135 of the Act requires the Board of Directors of every Company having :

a) Net Worth of Rupees 500 crore or more; or

b) Turnover of Rupees 1,000 crore or more; or

c) Net Profit of Rupees 5 crore or more,

during any financial year, to ensure that the company spends in every financial year atleast 2% of the average net profits of the company made during the three immediately preceding financial years on CSR in pursuance of its policy in this regard.

The Act requires such companies to constitute a CSR Committee which shall formulate and recommend to the Board a Corporate Social Responsibility Policy which shall indicate the CSR Activities to be undertaken by the company as specified in Schedule VII to the Act.

  • CSR ACTIVITIES AS PER THE ACT

1. Schedule VII to the Act provides the activities that may be included by companies in their CSR Policies Activities. The same are mentioned in brief below:

a) Eradication of extreme hunger and poverty;
b) Promotion of Education;
c) Promoting Gender Equity;
d) Reducing Child Mortality and Improving Maternal Health;
e) Women Empowerment;
f) Combating HIV-AIDS, malaria and other disease;
g) Ensuring Environmental Sustainability;
h) Employment Enhancing Vocational Skills;
i) Social Business Projects;
j) Contribution to Prime Minister’s Relief Fund and other such State and Central Funds;
k) Rural Development Projects;
l) Slum Area Development;
m) Protection of National Heritage;
n) Measures for the benefit of armed forces veteran, war widows and their dependents;
o) Promote Sports; and
p) Such other matters as may be prescribed.

2. CSR Expenditure shall include all expenditure including contribution to corpus, for projects or programs relating to CSR activities approved by the Board on recommendation of its CSR Committee, but does not include any expenditure on an item not in conformity or not in line with activities which fall within the purview of Schedule VII of the Act.

3. Only CSR activities undertaken in India will be taken into consideration.

4. Activities meant exclusively for employees and their families or undertaken in pursuance of the normal course of business will not qualify for CSR activities.

5. The amount spent in excess of 2% of the average net profits of immediately preceding 3 years cannot be carried forward for set off against the CSR Expenditure required to be spent in the future.

6. The Surplus arising out of CSR activities will have to be reinvested into CSR initiatives, and this will be over and above the 2% figure.

7. The company can implement its CSR activities through the following methods:

a) Directly on its own;

b) Through its own non-profit foundation set- up so as to facilitate this initiative;

c) Through independently registered non-profit organisations that have a record of at least three years in similar such related activities;

d) Collaborating or pooling their resources with other companies.

Further, the company ought to specify the project or programs to be undertaken through these entities, the modalities of utilization of funds on such projects and programs and the monitoring and reporting mechanism.

  • CSR GOVERNANCE AND REPORTING AS PER THE ACT

1. The CSR committee will be responsible for preparing a detailed plan on CSR activities, including the expenditure, the type of activities, roles and responsibilities of various stakeholders and a monitoring mechanism for such activities.

2. The Act requires that the Board of the company shall, after taking into account the recommendations made by the CSR committee, approve the CSR policy for the company and disclose its contents in their report and also publish the details on the company’s official website, if any, in such manner as may be prescribed.

3. The Format for the Annual Report on CSR Expenditure to be included in the Board’s Report is as under:

a) Brief Outline of the Company’s CSR Policy, including overview of the projects or programs to be undertaken.

b) Composition of the CSR Committee.

c) Average Net Profit of the Company for the last 3 financial years. 21

d) Prescribed CSR Expenditure.

e) Details of the CSR Spent during the financial year (FY):
– Total amount to be spent for the FY;

– Amount unspent, if any;

– Below Details of the amount spent during the FY

(i) CSR Project or Activity identified;

(ii) Sector in which the project is covered;

(iii) Projects or Programs – a) Local area or other; b) Specify the state or district where the project or programs was undertaken

(iv) Amount Outlay (budget) project or program wise

(v) Amount spent on the project or programs – a) Direct expenditure on projects or programs; b) Overheads

(vi) Cumulative Expenditure up to the reporting period

(vii) Amount spent: Direct or through implementing agency

f) If the company fails to spend the prescribed amount, the Board, in its report, shall specify the reasons.

g) A responsibility statement of the CSR Committee that the implementation and monitoring of CSR Policy, is in compliance with CSR objectives and policy of the company.

4. The amount of expenditure incurred on CSR Activities shall be disclosed by way of a Note to the statement of profit and loss account. It shall be recognized as a separate line item as ‘CSR Expenditure’ and consist of the following:

a) Gross Amount required to be spent by the company during the year.

b) Below disclosure, may be made to the notes to the cash flow statement, where applicable:

Amount spent during the year on                                    In Cash                   Yet to be paid in Cash Total

Construction / Acquisition of any Asset
On the purposes other than above

c) Details of related party transactions eg. Contribution to a Trust controlled by the company in relation to CSR Expenditure as per Accounting Standard 18, Related Party Disclosure.

d) Provision for CSR Expenditure and movement in the same needs to be presented as per Schedule III to the Act.

  • CSR EXPENDITURE – ACCOUNTING ASPECTS

1. “Average Net Profit” is the amount as calculated in accordance with the provisions of section 198 of the Act.

2. “Net Profit” means the net profit of the company as per its financial statement prepared in accordance with the applicable provisions of the Act. It shall not include the following:

a) Profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise; and

b) Any dividend received from other companies in India, which are covered under and complying the provisions of section 135 of the Act

3. “Net Worth” means the aggregate value of paid-up share capital and all reserves created out of the profits and securities premium account, after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off, as per the audited balance sheet, but does not include reserves created out of revaluation of assets, write back of depreciation and amalgamation.

In case of a foreign company covered under provisions of section 135 of the Act, net profit means the net profit prepared in terms of section 381(1)(a) read with section 198 of the Act.

4. Some Accounting Issues:

a) If the Company has already undertaken CSR Activity for which a liability has been incurred by entering into a contractual obligation, then in accordance with generally accepted principles of accounting, a provision for the amount representing the extent to which the CSR Activity was completed during the year, needs to be recognized in the financial statement.

b) In case the expenditure incurred by the company is of such nature which may give rise to an ‘asset’, the below treatment is to be appropriated:

(i) Where the control of the ‘asset’ is transferred by the company, it should not be recognized as an ‘asset’ in its books and such expenditure would need to be charged to the statement of profit and loss as and when incurred;

(ii) Where company retains the control of the ‘asset’ then it would need to be examined whether any future economic benefits accrue to the company. Future economic benefits from a ‘CSR Asset’ would not flow to the company as any surplus from CSR cannot be included by the company in business profits in view of Rule 6(2) of the Companies (Corporate Social Responsibility Policy) Rules, 2014.

c) In case where the company supply goods manufactured by it or render services as CSR activities, the expenditure incurred should be recognized when the control on the goods manufactured by it is transferred or the allowable services are rendered by the employees.

The goods manufactured by the company should be valued in accordance with the principles prescribed in Accounting Standard 2, Valuation of Inventories. The services rendered should be measured at cost. Indirect Taxes on the goods and services so contributed will form part of the CSR Expenditure.

d) The surplus arising out of the CSR projects or programs or activities shall not form part of the business profit of a company as per Rule 6(2) of the Companies (Corporate Social Responsibility Policy) Rules, 2014.

For accounting purposes, such surplus would be considered as income. However as the surplus cannot be a part of the business profits of the company, the same should immediately be recognized as liability for CSR expenditure in the balance sheet and recognized as a charge to the statement of profit and loss.

Salary paid by the companies to regular CSR staff as well as to volunteers to the Companies can be factored into CSR project cost as part of the CSR expenditure.

Expenditure incurred by Foreign Holding Company for CSR activities in India will qualify as CSR spend of the Indian subsidiary if, the CSR expenditure are routed through Indian subsidiaries and if the Indian subsidiary is required to do so as per Section 135 of the Act.

  • CSR – ROLE OF PROFESSIONALS

The corporate sector depends on professionals for governance, management and growth. Professionals can significantly contribute in discharge of social responsibilities as under:

a) Comply with the legal and regulatory framework of companies in letter and spirit by true and fair financial disclosure and tax compliance.

b) Advising on best corporate governance practices, business values, policies, plans, execution and discharging social responsibility.

c) Advising on business models where profit making and social welfare go hand in hand.

d) Advising on preferred local area around the operations of companies for spending the amount earmarked for CSR activities.

e) Advising on viability of public-private partnership (PPP) and corporate-aided community projects.

f) Carry out audit on the below social areas:

1. Social Responsibility Audit;

2. Environmental Audit;

3. Waste Management Audit.

For more information / clarifications, kindly post your queries on niyati.ca@gmail.com

Basic Concepts of International Taxation

Going global is impressive, yet is much more complex than meets the eye. To successfully convert a domestic business to an international one, a host of factors needs to be considered. Further, on one side the advent of internet has been a key business enabler and a leveler for SMEs, on the other side it expects to bring about disruption in the traditional business models. India is now the second largest Internet economy and E-Commerce is expected to be 10 times the current size by 2020.

Presently, India fares to be the top destination for Foreign Direct Investment (FDI). Strong FDI inflows depict India’s robustness as an investment destination for businesses in an environment of slow global growth. Further Government of India has also eased FDI norms in major sectors like Insurance, Defence, Construction, Media, Civil Aviation etc.

FACTORS AFFECTING INTERNATIONAL BUSINESS:

  1. Country Profile
  2. Investment Climate and Foreign Trade
  3. Market Knowledge and Local Competition
  4. Language and Communication Barriers
  5. Organizational Readiness
  6. Entry Strategies / Form of Business Enterprise
  7. Funding of Business
  8. Repatriation of Funds
  9. Tax Code
  10. Exit Strategy

[A] INBOUND INVESTMENTS

[1] ENTRY OPTIONS IN INDIA:

  1. Liaison Office
  2. Branch office
  3. Local Indian Subsidiary Company
  4. Project Office
  5. Limited Liability Partnership (LLP)

[2]  COMPARATIVE MATRIX OF VARIOUS FORMS OF BUSINESS

Sr. Particulars Liaison Office Project Office / Branch Office Subsidiary Company LLP
1 Legal Status Represents the Parent Company Extension of Parent Company Independent Legal Status Independent Legal Status
2 Process of Setup Easy Easy Complex Moderately Complex
3 Scope of Activities Liaison Activities Restricted Scope Significant flexibility Activities for which 100% FDI is allowed without any approval
4 Compliance Requirements Limited Limited High High
5 Income-tax Rate Generally, no tax liability since it cannot carry out any commercial or income-earning activities 43.26%* on net income basis 33.99%# on net income basis. If MAT is levied, it is levied at 20.96%^ of its book profits) 33.99%# on net income basis. If AMT is levied, it is levied at 20.96%^ of its book profits)
6 Ease of Exit Easy Easy Complexity depending on type of strategy adopted Complexity depending on type of strategy adopted

 

* 43.26% (40% plus 5% SC plus 3% cess thereon) for Assessment Year 2015-16

# 33.99% (30% plus 10% SC plus 3% cess thereon) for Assessment Year 2015-16

^ 20.96% (18.5% plus 10% SC plus 3% cess thereon) for Assessment Year 2015-16

 

[3]  FUNDING OF INDIAN BUSINESSES:

Funding of Corporate Organizations

  1. Equity Share Capital
  2. Preference Share Capital
  3. Debentures and Borrowings
  4. External Commercial Borrowings
  5. ADRs, GDRs, FCCB
  6. Listing of Debentures to raise funds

Funding of LLP

LLPs are not permitted to avail ECB. Therefore, capital invest is the only mode of funding for LLPs.

[4] COMMON TRANSACTIONS BETWEEN ASSOCIATED ENTERPRISES 

  1. Purchase / Sale of raw materials, consumables or any other supply;
  2. Purchase / Sale of traded / finished goods;
  3. Transactions of Intangible property;
  4. Provision of Services;
  5. Lending / Borrowing of Money;
  6. Purchase / Sale of marketable securities, issue and buyback of equity shares, debentures, preference shares etc.;
  7. Transaction in respect of mutual agreement / arrangement;
  8. Transaction arising out of business reorganization / restructuring; etc.

[B] OUTBOUND INVESTMENTS

[1]  KEY DRIVING FACTORS:

  1. Overseas Expansion
  2. Overseas Listing
  3. Spreading of Risk
  4. Ensuring Supply Chain
  5. Access to Wider Global Markets

[2] ROUTES FOR OUTBOUND INVESTMENT:

  1. Specifically Prohibited Activities
  2. Automatic Route through Authorised Dealer
  3. Approval Route – Prior approval of RBI

[3] MODES OF OUTBOUND INVESTMENT

Joint Venture

Foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country in which the Indian party makes a direct investment.

Wholly Owned Subsidiary

Foreign entity formed, registered or incorporated in accordance with the laws and regulations of the host country, whose entire capital is held by the Indian Company.

[4] FUNDING OPTIONS:  

  1. Draw Foreign Exchange from AD Bank
  2. Proceeds of ECB / FCCBs
  3. Proceeds of foreign currency funds raised through ADRs / GDRs
  4. In exchange of ADR / GDRs
  5. Swap of Shares
  6. Balance held in EEFC Account of Indian Party
  7. Capitalization of Exports

INCOME TAX AND BASIC CONCEPTS OF INTERNATIONAL TAXATION 

  1. Incidence of Tax

Income Tax Act, 1961 (the Act) governs the Income tax liability in India. Income tax liability in India is determined on the residential status. For a resident, the world wide income is taxable. For a non-resident, India sourced income is taxable.

India sourced income is income earned through a business connection in India or through transfer of a capital asset, being any share or interest in a company incorporated outside India, deriving its value substantially from assets located in India or through other Indian sources.

  1. Double taxation in cross border transactions

A taxpayer entering into a cross border transaction may be liable to be taxed in his home country (i.e. the country of his fiscal residence) on his world income. This is generally known as the ‘residence rule’ of taxation. He may also be taxed in the country from which he earns income even though he is not a resident of that country. This is referred to as ‘source rule’ of taxation. The purpose of Double Taxation Avoidance Agreements (DTAA) between two nations is mainly to avoid such double taxation.

  1. Beneficial Provisions to apply

If there is a DTAA between India and the country of non-resident, the provisions of the Act or the DTAA, whichever is more beneficial shall apply. However in order to be eligible for DTAA benefits, a non-resident is required to obtain a valid Tax Residency Certificate (TRC) issued by revenue authorities of the country of residence and other information or documents as may be prescribed.

  1. Who can access a tax treaty

A taxpayer, to be able to access a treaty, should necessarily be a ‘resident’ of atleast one of the two countries of which the treaty is to be accessed.

  1. Treaty Shopping

If only a ‘resident’ of one of the two states can access a treaty, a resident of a third country cannot, therefore, have any access to a treaty. However, when a resident of a third country, establishes an entity in one of the two countries that have entered into a treaty in order to take advantage of the provisions of that treaty, it is called ‘treaty shopping’.

  1. Limitation of Benefits (LOB)

Some treaties make specific provisions so as to ensure that the persons taking advantage of the treaty are, in substance, residents of one of the two contracting states.  Different objective tests are prescribed in the treaty. The person failing to satisfy the tests prescribed in the treaty in this regards would be deprived from the benefits available in the treaty.

  1. Beneficial Owner

Most  of the treaties provide that the concessional tax treatment provided under the treaty would be available if the person concerned is the “beneficial owner” of the relevant income. Control is regarded as the most important factor to determine beneficial ownership.

  1. Force of Attraction Rule (FAR)

Generally as per the normal provisions, only the profits attributable to a Permanent Establishment(PE) are taxable in the source country.  However, the basic philosophy underlying Force of Attraction Rule is that when an enterprise sets up a PE in another country, it brings itself within the fiscal jurisdiction of that other country to such a degree that such other country can properly tax all profits of that enterprise derived from that country – whether through PE or not.

FAR provides that the profits earned by the enterprise would be attributed to the PE if such profits have arisen to the enterprise from direct sale of same or similar goods, as are effected through PE, or through other activities (say rendering of services) under same or similar circumstances in which its PE does.

However, certain treaties provide that if it can be proved that the PE has not played any role in the direct business of the HO, in such a case Force of Attraction need not be applied.

  1. Transfer Pricing

Transfer Pricing provisions provide that profit arising from international transactions between two or more associated enterprises should be computed having regard to “arms length price”. Arm’s length price is a price that is adopted in similar transactions between to or more unrelated parties.

  1. Thin Capitalization

Thin Capitalization rules are found in many countries to provides a deterrent against artificial structuring of capitalization with a view to create lower tax burden. Interest on loan is a tax-deductible expenditure, while dividend on shares is not. As a result of this , a tax payer in country ‘A’ desiring to set up a business in country ‘B’ may opt for capitalizing its business in such a manner that there is a higher debt and a lower capital flowing from the owners.

Domestic laws of some countries have formulated rules against such ‘thin capitalization’ by providing some minimum capitalization norms. Thus thin capitalization is a tool used by tax authorities to prevent what they regard as a leakage of tax revenue as a consequence of the way in which a company is financed.

  1. Tax Sparing

Tax treaties provide for a mechanism by which the home country of a tax payer grants him credit in respect of the taxes paid by him in the source country in accordance with the provisions of the treaty.

  1. Underlying Tax Credit

In the concept of underlying tax credit, the credit is given for the tax paid by the underlying entity. It is also known as “Indirect tax credit” method because shareholder receives credit for tax, which it has only paid indirectly.

  1. General Anti Avoidance Rules (GAAR)

GAAR is an anti-avoidance regulation of India. The regulation allows tax officials to deny tax benefits, if the transactions lack commercial / economic substance, Rights / obligations are not at arm’s length, transaction is not for a bona-fide purpose or is an abuse of provisions of the Act. GAAR provisions shall be applicable from 1 April 2017.

EVC for electronically verifying Income-tax return

Notification No. 2/2015  

EVC to verify Income-tax return

As per the above referred notification, Electronic Verification Code (EVC) is a 10 digit alpha numeric code generated for the purpose of electronic verification of the person furnishing the return of income.The same is not applicable to assesse’s where digital signature is mandatory i.e. a company assessee, person required to get accounts audited as per section 44AB of the Income-tax Act and a political party.

With the help of the EVC, return can be verified and there is no need to send ITR-V Acknowledgement to Bangalore.

The procedure and standards of EVC are as under:

a) EVC would be generated on the E-filing website –www.incometaxindiaefiling.gov.in
b) Individual can verify his return or of an HUF of which he is a Karta throughEVC
c) EVC will be unique for an Assessee PAN
d) One EVC can be used to validate one return of an assessee
e) The verifier can use more than one mode to obtain EVC and can generateEVC multiple times

Validation of EVC

The EVC used to verify Income-tax return will be validated against the EVC stored against the Assessee’s PAN at the time of generation. Only a valid and matchedEVC will be accepted. Invalid, already used and unmatched EVC shall be rejected.

4 Modes of Generation of EVC

1. Net Banking  

a) Where the total income as per Income-tax return is greater than Rs. 5 lakhs and there is refund claim, verifier has to generate EVC through net banking
b) Specified Banks provide direct access to the e-filing website for account holders having validated PAN
c) When user logs in via net banking and seeks redirection to e-filing, he/she will be redirected to e-filing website where he can generate EVC

2. Aadhaar Authentication 

a) A verifier can provide his Aadhaar number for linking with his PAN on the e-filing website – www.incometaxindiaefiling.gov.in, verified on the basis of his name, date of birth and gender
b) If the Aadhaar authentication is successful, the verifier’s Aadhaar will be linked to his PAN
c) An OTP will be generated and sent to the registered user’s mobile number as per Aadhaar records
d) The OTP is the EVC and can be used to verify Assessee’s Income-tax return
e) The Aaadhar OTP as EVC will be valid for 10 minutes

3. ATM of a Bank

a) Verifier whose ATM card is linked to PAN validated registered Bank Account can generate EVC through this mode
b) A verifier can access the ATM of the bank in which he / she has an account using ATM (debit / credit) card
c) After due authentication by using ATM Pin at the Bank ATM, the verifier can select the ‘Generate EVC for Income-tax return filing’
d) EVC will be sent to the assessee’s registered mobile number with e-filing  and can be used to verify assessee’s Income-tax return

4. E-Filing Website

a) Where the total income as per Income-tax return is Rs. 5 lakhs or below and there is no refund claim, verifier can generate an EVC on E-filing website
b) EVC will be sent to Registered E-mail Id and Mobile Number of the assessee with E-filing website and can be used to verify assessee’s Income-tax return

Click here for User Manual

Please connect to us if you seek any further information / clarification.
K. T. Hemani & Co. 
Chartered Accountants
t:  0281-2444037
w: kthemani.com
a: Ruchini M46, GHB, Street No. 1, Kalavad Road, Rajkot  – 360 001

Relevant TDS Amendments in Union Budget 2015

Sr.

Sec

Main Heading

Amendment

Action Points

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1 192 Tax deduction from Salary Employer shall obtain from employee, the proofs of claims (incl. set-off of house property loss) made by him in the prescribed form and manner from 01/06/2015. Prescribed Form has not yet been notified. A simple declaration from the employee may be obtained
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2 192A TDS on Employees provident fund scheme With effect from 01/06/2015, tax is to be deducted by trustee / person authorised to make payment under Employees’ Provident Fund Scheme, 1952 as under:
a) On  premature withdrawal / lumpsum payment to employees provident fund amount when the employee has not rendered continuous service of 5 years;
b) Tax is deductible under section 194A at the rate of 10% of “taxable premature withdrawl” plus applicable surcharge and cess where the PF amount is Rs.30,000 or more. If PAN of the recipint is not available, tax is deductible at the maximum marginal rate of tax (i.e., at 34.608% for the financial year 2015-16).
A declaration in Form 15G / 15H maybe filed by the employee that his total income does not exceed maximum amount not chargeable to tax.
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3 194A TDS on Interest by co-operative bank to its members on time and recurring deposits With effect from 01/06/2015, tax will be deductible by co-operative banks on payment/credit of interest on time deposits exceeding Rs.10,000/-  to its members except where the depositor is a co-operative society. A declaration in Form 15G / 15H maybe filed with the Co-operative bank for non-deduction of tax
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4 194C TDS on payments made to resident transporters With effect from 01/06/2015, exemption from non-deduction of TDS on transport charges payments to a contractor shall apply only if the following conditions are fulfilled:
1. Recipient is engaged in the business of transport;                                                                                                                 2. Recipient owns 10 or less goods carriages at any time during the financial year;
3. Recipient furnishers a declaration to this effect along with PAN.
Declaration to be obtained from transported owning 10 or less than 10 goods carriages
 
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5 195 Non-Resident Payments With effect from 01/06/2015, person responsible for paying to a non-resident / foreign company, any sum (whether or not chargeable to Income-tax in the hands of recipient) shall furnish the information relating to payment of such sum, in Form 15CA and 15CB File remittance details in Form 15CA and CA Certificate in Form 15CB in respect of all non-resident payments
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6 206C Tax Collected at Source A correction statement for rectification of any mistake or to add, delete or update the information furnished in the statement may be filed in such form and verified in such manner, as may be specified Prescribed Form has not yet been notified.

 

Union Budget 2014-15

17/07/2014 – Article on Union Budget 2014-15

Acche Din Aayenge !?

The maiden budget from the NaMo led government placed before the parliament on 10 July 2014 was most sought after by the people of India to DISCOVER the CHANGE and EMBARK on RAYS OF ACHHE DIN. Hopes and expectations were attached f rom the HIGHLY MANDATED and DEVELOPMENT ORIENTED NaMo led government. However, considering high fiscal deficits, GDP of less than 5% in past two years, rising inflation, uncertainties of the global economy and with only 45 days on hand, less could be mana ged in the realm of fiscal manoeuvrability.

Yet clearly skill development, e-governance, leveraging technology for social infrastr ucture (education and healthcare), reviving traditional industries and encouraging entrepreneurship were the MANTRAS for the NEW GROWTH MODEL. Investment plans for ports, airports, roads, agri-infra, railways, energy, defense, urbanisation and smart cities, water transport etc. were talked about.

In this article, I have tried to analyze the impact of some of the provisions of the union budget 2014 keeping in mind the investor community so as to say the AAM ADAMI

A. Tax Savings

• Personal income tax basic exemption limit raised to Rs.2.5 lacs from Rs.2 lacs for general category of individuals. For senior citizens basic exemption limit raised to Rs.3 lacs from Rs. 2.5 lacs. • Sec 80 C deduction limit increased to Rs.1.5 lacs from Rs.1 lacs. • Interest on housing loan deduction increased from Rs. 1.5 lacs to Rs. 2 lacs in case of self-occupied property

B. Investment Savings

• Reintroduction of Kisan Vikas Patra, a bond like instrument in which the invested money doubles in a given period. It shal l channelise unbanked money.

• A small saving scheme named after the girl child to cater to the requirements of education and marriage of girls.

• Relaunching of Varishta Pension Bima Yojana for senior citizens of over 60 years starting August 15.

• Employee Provident Fund and Pension scheme – The mandatory wage ceiling for PF contribution increased from monthly pay of Rs.6,500/- to Rs.15,000/. Also, employees covered under Employees Pension scheme will receive a minimum monthly pension of Rs.1,000/-.

• The investment limit for PPF has also been raised from Rs. 1 lac to Rs. 1.5 lacs allowing investors to claim tax free interest and claim benefit under section 80C as above.

• In the light of the long term capital gains tenure now extended to 3 years, investors could find favour with long duration bond and guilt funds. Preferences could be more for accrual funds as they have higher portfolio yield to maturity.

• While FIIs continue to pour money and that domestic economic revival is underway and the valuations are also reasonable, Equity market is likely to pick up.

Savings

I n c r e a s e  i n  Pe r s o n a l  Ta x Exemption Limit, Tax Saving Investment Exemption Limit, Deduction of Interest on housing loan of a self occupied property shall all result in incremental cash flows in the hands of investor and is positive for the financial sector.

Sectoral Impact

Power and Infra are clearly two focus areas since the sunset clause for power units are extended as also support is provided to Infrastructure lending along with infrastructure d e v e l o p m e n t . Po s i t i v e f o r Banking sector with measures like capitalisation of PSU Banks. Insurance sector shall get a boost as FDI limit in the same has been relaxed. Entrepreneurs and manufacturing industry are e n c o u r a g e d b y p r o v i d i n g d e d u c t i o n o f i n v e s t m e n t allowance.

FII

Measures like relaxation on FDI limits, tax incentives including lower withholding tax for all types of bond investments by foreign investors, pass-through status on REITs, Infrastructure investment trust, clarity on sale of securities by FII to be treated as capital gains have augured well the confidence of FII in the Indian market.

Taxation

Duration and Taxability of Long Term Capital Asset – Unlisted securities and mutual funds, other than equity oriented mutual funds shall qualify as ‘long term capital asset’, if held for more than 36 months (earlier limit: 12 months). This move is to bring parity with bank and other debt instruments. Further, tax rate on sale of long term listed mutual funds (other than equity-oriented mutual funds) is proposed to be taxed at a flat rate of 20%. Earlier, such unlisted securities were taxable at t h e r a t e o f 1 0 % w i t h o u t indexation or at 20% with indexation whichever is lower.

Proposed to calculate Dividend Distribution Tax on ‘gross’ basis instead of ‘net’ basis.

DDT under section 115-O – Increased from @16.995% to 19.9941% of dividend amount distributed

DDT under section 115-R – Income distribution on equity oriented funds: Nil Income distributed by Mutual Fund to an Individual/ HUF: Increased from 28.325% to 37.7667% and that of any other person: Increased from 33.99% to 48.557%

 

Sr.   Market Impact

1      MFs fear outflows, AMFI has asked regulator SEBI to defer long term capital gains tax on debt oriented MFs to next financial year.

2      AMFI has also taken up the matter with the Ministry of Finance, “To have the long-term capital gain tax on closed ended debt schemes and not on open ended debt schemes, gold exchange traded funds and funds of funds etc, as this would render this asset class unattractive for investment.This in turn could impact the liquidity and development of corporate bonds.”

3     Big corporates are now leaning on the finance ministry to make the changes effective from a prospective date and provide grandfathering element for the existing investors

4     Fixed Maturity Plans (FMP) and short-term bond funds are expected to be hit due to change. Switch of funds from debt funds to bank deposits is likely as the latter will have similar tax treatment.

5     A report by The Economic Times states that at least four fund houses have deferred their FMPs and two have even returned cash collected from investors for issues that closed last week.

  • MFs exposure to bank stocks hits record-high of Rs 55k cr. This was also the fifth consecutive monthly rise. After banking, software is the second most preferred sector with MFs having exposure followed by pharmaceuticals and Finance. Market valuation at this point in time looks fairly valued.
  • RBI and the government are trying to tackle to get the long-term funding market better for the infrastructure projects. However, given the weak monsoon and its impact on inflation, it is unlikely for the RBI to give support in form of interest rate easing soon.
  • Real estate experts have given the budget a big thumbs-up as it focuses evenly on housing and development with both domestic and foreign investments in the sector. The development of smart cities can bring opportunities for real estate developers, investors, end users and the housing loan sector. Introduction of real REITS is a welcome move as it is likely to increase liquidity in the cash strapped sector. With Slum development being made a part of CSR activities, the government seems to have its heart in the right place.
  • Infrastructure bottlenecks continue to remain critical for the farm sector. Efforts for 2nd green revolution, setting aside funds for climate change and irrigation, introducing Kisan TV for effective dissemination of knowledge – all these would ensure a long term positive impact on farm productivity for farmers.

C. Certain Direct Tax Burdens

• Deduction of tax at source from payment in respect of life insurance policy

With effect from 1 October 2014, tax to be withheld at the rate of 2 per cent at the time of payment on sum paid under a life insurance policy, including the sum allocated by way of bonus, which are not exempt. It has also been proposed that no deduction of tax under this provision shall be made if the aggregate sum paid in a financial year to an assessee is less than INR 1,00,000.

• Capital gain on transfer of certain capital assets not to be charged in case of investment in only one residential house

This amendment clarifies that ‘a’residential house has now to be restricted to ‘only one residential house situated in India’.

• Capital gain not to be charged on investment in certain bonds made in the financial year

The existing provision states that the investment made in the long-term specified asset during any financial year shall not exceed fifty lakh rupees. The amendment clarifies that the tax exemption will be limited to Rs. 50 lakhs even where re-investment in certain bonds is split between two different financial years.

• Transfer Pricing – Definition of deemed international transaction expanded

Amendment seeks to broaden the scope of a deemed international transaction. The deeming fiction would continue to apply irrespective of whether the non-associated enterprise is a resident or not. Hence the deeming fiction would now also extend to transactions between two resident enterprises.

• Non-Deductibility of the CSR Expenditure

As the CSR expenditure, being an application of income, is not incurred for the purposes of carrying on business, such expenditures cannot be allowed under the existing provisions of section 37 of the Income-tax Act. However, the CSR expenditure which is of the nature described in section 30 to section 36 of the Income-taxAct shall be allowed as deduction under those sections subject to fulfilment of conditions, if any, specified therein.

D. Towards Direct Tax Certainty

• Speculative Transaction

It is proposed that eligible transaction in respect of trading in commodity derivatives carried out in a recognised association which is chargeable to commodities transaction tax shall not be considered to be a speculative transaction.

Disallowance on account of non-withholding of tax

In the case of non-deduction / non-payment of tax at source made to residents, the disallowance of the expenditure will be confined only to 30% of such expenditure and not the full amount.

• Investment Allowance

Additional investment allowance at 15% to manufacturing companies that invests Rs. 25 crore in any year for next 3 years.

• Taxability of Dividends from a Foreign Company

The current provisions relating to taxation of gross dividends received by an Indian company from a specified foreign company at the concessional rate of 15% have now been proposed to be extended to AY 2015-16 and subsequent years.

• Characterisation of Income in case of Foreign Institutional Investors (FIIs)

It is proposed to amend the definition of “capital asset” to provide that any security held by FII which has invested in such security in accordance with the regulations made under SEBI would be treated as capital asset and income arising from transfer of such security would be taxable as capital gains.

• Transfer Pricing

APA rollback provisions introduced. Proposes “range concept” for ALP computation instead of arithmetical mean, except where adequate number of comparable are not available. Use of multiple year data to be allowed for transfer pricing benchmarking.

• Retrospective Amendments

All cases of indirect transfers arising out of retrospective amendments will be scrutinised by a high level committee of CBDT, before initiating any action.

• Scope of AAR

AAR scope to be expanded to resident private limited companies. This is a good indication for errorfree and litigation free working.

E. Conclusion

The NaMo led government did try to ensure that no section of society or any part of the country is missed out in getting a mention in the Budget. However, the budget didn’t provide clarity on GAAR, issue of bank recapitalisation, plan towards introducing the unified Goods and Services Tax (GST) and a concrete plan of rationalisation of subsidies (Food, fuel, fertiliser). The uncertainty created by retrospective taxation measures need to be permanently put behind.

The most awaited event of 2014 is behind us ….. equity market’s attention would now move to global events, corporate earnings and real ‘action’ on the ground.Seems for now that the ACHHE DIN KEY lies in EFFECTIVE EXECUTION and IMPLEMENTATION.

This article is contributed by CA Niyati Hemani, Associate of K. T. Hemani & Co. For any clarifications, kindly e-mail on niyati.ca@gmail.com

Select Issues in Capital Gain

 

26/02/2014 – Article on Select Issues in Capital Gain

Select Issues in Capital Gains

As is generally understood, revenue receipts constitute income whereas a capital receipt is not an income. But, under the provisions of the Indian tax law, a capital receipt can be charged to tax, if the following three conditions are satisfied:

1) There is a capital asset;

2) There is a transfer of a capital asset;

3) The capital gain is computed in accordance with the provisions of the Indian tax law

Let us briefly understand the above three conditions.

A capital asset means property of any kind held by an assessee. However, certain properties are excluded viz., stock-in-trade, rural agricultural land, personal effects, such as wearing apparel, furniture etc. held for personal use and certain bonds.

Transfer in relation to a capital asset includes inter alia, the sale, exchange or relinquishment of the asset, extinguishment of any right therein, conversion of a capital asset into stock-in-trade etc. Further, the Indian tax law also specifies certain transactions that are not to be treated as transfer for the purpose of capital gain. The date / year of transfer is material for levy of capital gain tax.

Capital Gain is computed by deducting following from the full value of consideration:

1) Cost of Acquisition;

2) Cost of Improvement; and

3) Expenditure incidental to transfer

Prior to AY 2012-13, as per judicial pronouncements, where the full value of consideration could not be determined, the above machinery provision would fail and therefore there would be no capital gain. However with effect from AY 2012-13, the fair market value on the date of transfer shall be deemed to be the full value of consideration where the actual consideration cannot be determined or is not ascertainable.

In this article, I shall cover some relevant updates / issues on the below:

1) Revised distance limits for Urban Agricultural Land

2) Shares and Securities Test – Held as Stock in trade vs. Investment

3) Depreciable Assets – Claim of Depreciation, Exemption benefits and set-off of losses

4) Family Arrangement – Asset acquired by Succession, Inheritance, Gift, Will etc.

5) Business Restructuring – Succession of a Sole Proprietary concern / Firm by a company

1. Revised distance limits for Urban Agricultural Land

An urban agricultural land is not excluded from the definition of a capital asset and as a result, profit and gain on sale of urban agricultural land is liable to capital gains tax. An Urban land is a land situated within the jurisdiction of municipality or cantonment board having population of more than ten thousand. Urban land also includes a land outside the urban area and situated within the specified distance from local limits of such urban area.

Upto AY 2013-14, such specified distance was eight kilometres.

From AY 2014-15, such specified distance is divided into three parts:

 

Urban Area Population                    Specified Distance

Between 10,000 and 1,00,000                                     2 Kms

Between 1,00,000 and 10,00,000                                 6 Kms

More than 10,00,000                                                 8 Kms

 

Further, upto AY 2013-14, the above distance was measured by road. However, from AY 2014-15, the distance has to be measured aerially.

2. Shares and Securities Test

Held as Stock in trade vs. Investment The Indian tax law makes a distinction between a capital asset and a trading asset. Gain / Loss on sale of capital asset is taxable as capital gain and gain / loss arising of a trading asset is taxable as a business income.

The issue of whether shares and securities were held as investment or as stock-intrade is often questioned by the income tax department and there are various judicial pronouncements laying down the factors for determining the same. A CBDT circular has provided guidance in determining the nature of shares and securities as investment or stock-in-trade.

Though the issue is a mixed question of law and fact, yet the below tests help in establishing the nature of the share and securities:

i. Claim accepted in earlier year accepted by department – principles of consistency

Under the same facts and circumstances, where the department has accepted holding the shares as investment, as per principle of consistency, the position cannot be allowed to change, merely because a different view is possible.

ii. Holding Period of Shares

Holding period is not conclusive but it does indicate whether the transaction is for investment or for earning motive. The length of time, nature of dealings, how proceeds of sale are dealt with etc. would determine the question whether a particular transaction is in realization of investment or a sale in ordinary course of business.

iii. Two separate portfolios

To establish the nature of investment vis-a-vis business activity, assessee may maintain two separate portfolios i.e. one for investment and another for stockin-trade.

iv. Intention of the assessee

Intention at the start of the activity, which is reflected in the conduct of the assessee and the way he treats the transaction is the most important factor to be considered keeping in view the adjoining circumstances.

v. Volume and number of transactions, quantum of investments

The frequency, volume and value of transaction though critical cannot be the only criteria for determining the nature of activities carried on by the assessee.

vi. Use of borrowed funds

The use of borrowed funds for the purpose of buying shares has often been considered by Courts as an indication as to the share transaction activity being in the nature of investment or business.

3. Depreciable Assets – Claim of Depreciation, Exemption benefits and set-off of losses

Where the capital asset is an asset forming part of a block of asset in respect of which depreciation has been claimed, in computing capital gain, the cost of acquisition of such a depreciate asset shall be computed as under:

i. Written down value of such block of assets at beginning of the previous year;

ii. Actual cost of any asset acquired during the previous year and falling in block;

iii.Expenditure incurred wholly and exclusively for such transfer(s).

The difference between the full value of consideration and cost of acquisition as computed below shall be deemed to be short term capital gain.

The intention behind this provision is that assessee should not enjoy double benefits i.e. depreciation as well as indexation.Accordingly, judicial pronouncements have held that where depreciation has neither been claimed nor been allowed on a particular asset, the above computation provision is not applicable.

Further, the above provision is only to deem the transaction of capital gain on depreciable asset as short term capital gain and not to deem an otherwise long-term capital asset as short-term capital asset. Accordingly, when an assessee transfers an asset for which depreciation has been allowed but the asset is a ‘long term’, as per various judicial pronoun cements, the assessee is eligible for relevant exemptions under the Income tax law. Also, brought forward loss out of long term capital asset can be set off against gains computed above.

4. Family Arrangement

Asset acquired by succession, inheritance, gift, will etc. A family arrangement does not amount to transfer and hence not exigible to capital gain.

Further, where the capital asset has become the property of the assessee by way of gift, will, succession, inheritance or the asset is acquired at the time of partition of family or under a revocable or irrevocable trust or under amalgamation, etc., the period of holding shall include the period for which the asset was held by the previous owner. And the cost of acquisition shall be deemed to be the cost for which the previous owner of the property acquired it.

5. Business Restructuring – Succession of a Sole Proprietary concern / Firm by a company

As per provisions of the Indian tax law, where a sole proprietary concern / partnership firm is succeeded by a company in the business carried on by it as a result of which the sole proprietary concern / partnership firm sells or otherwise transfers any capital asset or intangible asset to the company, the same shall not be liable to capital gains tax provided that certain conditions are fulfilled.

The cost of acquisition of the capital asset in such a case shall be deemed to be the cost for which the previous owner acquired it plus the cost of any improvements of the assets incurred or borne by the previous owner or the assessee.

If the conditions specified are violated, the profits and gains from the transfer of capital asset not charged to tax earlier shall be deemed to be income chargeable under the head capital gain of the successor company for the previous year in which the conditions are not complied with.

This article is contributed by CA Niyati Hemani, Associate of K. T. Hemani & Co., Chartered Accountants. For any clarifications, kindly e-mail on niyati.ca@gmail.com.

Limited Liability Partnership

 

23/12/2013  – Article on Limited Liability Partnership 

 

Constituent of Limited Liability Partnership

Limited Liability Partnership [LLP] as a business vehicle has been recognised worldwide. Internationally in countries like UK, France, USA, Singapore, Japan, China, Canada, Germany etc., LLP is preferred as a business medium especially for the service sector, realty sector, Joint Ventures / Special Purpose Vehicles etc.

In India, LLP, a body corporate (which is hybrid of a company and a partnership) has been introduced through Limited Liability Partnership Act, 2008 [LLP Act]. Subsequently, in respect of registration and operational aspects under the LLP Act, the Limited Liability Partnership Rules, 2009 [LLP Rules] were notified by the Government.

Due to its organisational flexibility coupled with limited liability, LLP is beneficial not just to entrepreneurs, professionals and enterprises providing services but for other propositions as well. Before delving into it further, we briefly understand the salient features of LLP.

Sr.  Incorporation Steps

1    Select Partners / Designated Partners

2    Obtain DPIN

3    Check Name Availability

4    Draft LLP Agreement

5    File Incorporation documents

6    Issue of Certificate of Registration

Salient Features of LLP 

  • Body Corporate – LLP is a body corporate and a legal entity distinct from its partners and has perpetual succession. This is a distinct advantage of LLP over partnership firms since the latter do not enjoy a perpetual succession.
  • Flexible to Manage – LLP is managed as per the LLP agreement. However, in the absence of such agreement, LLP would be governed by framework provided in Schedule I of the LLP Act.
  • Partners – A minimum of two partners are required to form an LLP. There is no maximum limit on number of partners. An individual or a body corporate may be partner in the LLP. Partner may lend money to and transact other business with LLP. Due to this advantage of LLP, carrying on big venture with small contribution from large number of partners is possible in LLP.
  • Designated Partners – LLP shall have atleast two individuals as designated partners and atleast one of whom shall be resident in India. The designated partner shall be responsible for all the compliances, rules and provision to be complied by the LLP.
  • Agency – All partners shall act as the agent of the LLP but not of the other partners.
  • Contribution by Partners – The contribution of a partner may consist of tangible, movable or immovable or intangible property or any other benefit to the LLP. However, as required for companies there is no minimum amount of contribution required.
  • Liability of Partners – The liability of a partner is limited to the amount of the contribution. However, a partner is personally liable for his own wrongful act i.e. act which is not authorised by LLP or for fraud on his part.
  • Separate Property – The LLP as legal entity is capable of owning its funds and other properties. The property of LLP is not the property of its partners.
  • Related party transactions – No restriction on entering contracts with related parties.
  • Investment – LLP can invest in shares of other Companies.
  • Compliances – There are minimum compliance required under the LLP Act. Books of Accounts are to be maintained at the registered office for such period as may be prescribed. Statement of accounts and Solvency [SAS] are to be prepared within 6 months from end of the Financial Year [FY]. Accounts of LLP must be audited in case contribution/turnover exceeds 25 Lakh/40 Lakh in a FY. Annual Return must be filed with Registrar of Companies [ROC] within 60 days of end of the FY.
  • Raising Money – The LLP being a regulated entity like company can attract finance.
  • Capacity to sue – As a juristic legal person, the LLP can sue in its name and be sued by others.
  • Provisions relating to transferability of Partner’s interest in LLP, conversion of partnership firm, pvt. ltd. company and unlisted public companies exist. Also stipulations are laid down for Compromises, Arrangement or Reconstruction of LLP as also it’s winding up and dissolution.

How popular are LLPs ?

LLP was expected to be the next popular business vehicle after the Company. However, the number of LLPs formed are not very encouraging. Some notable reasons for the same are:

Lack of Privacy – Incorporation document, details of partners, accounts, SAS and annual return filed with ROC would be available for public inspection.

No major tax advantage – The introduction of Alternate Minimum Tax [AMT] has dented the tax advantage of LLP.

Binding Act of Partners – Any act of partner without the other partner, may bind the LLP.

Extended liability of Partners – In cases of fraud etc., the liabilities of partners are extended to their personal assets. Further, for loans even banks insist personal guarantee of partners.

Finance constraints – LLP cannot raise money from public. Also, banks are hesitant to provide finance to LLPs since LLPs do not provide sufficient protection as that in a company viz. Provision of filing charge, restriction on withdrawal of capital, requirement of statutory audit, restriction on related party transactions etc.

Despite the above, LLP still remains a viable medium in the long run due to its inherent flexible structure. Further, as the cost of running LLP is lower, small businesses which can be carried on with own funding can convert into LLP.

LLP is a useful medium for the below propositions:

Investment vehicle – LLP may hold the shareholding of family owned companies. Further, it may be easy to plan the affairs of the LLP as it is managed as per the LLP Agreement which also outlays the rights and duties of the partners.

Alternate to forming a Subsidiary company – Incase of a business conglomerate, the flagship company may form an LLP for its ancillary businesses instead of a subsidiary company. LLP shall provide operational flexibility, lesser regulations to be complied as also save on the tax cost viz. Dividend Distribution Tax [DDT], deemed dividend provisions etc.

Suited vehicle for businesses with potential lawsuits – As liability for repayment of debts and lawsuits incurred by the LLP lies on it and not on the partners, it provides an added layer of protection.

Key Employee Benefit Enterprise – Business houses desiring to reward key employees, may entrust associated or ancillary business to employee constituted LLP. It will ensure efficient accomplishment of work and also some extra reward for employee groups.

Concept Sale – LLP is suited where the promoter is desirous of setting up a business activity and after the activity gears up, selling it off. Change of hands become possible by making modifications in the LLP document without any need for other changes in registrations etc.

Project Business – In a project where diverse skill sets are required, a typical need of entrusting the whole responsibility with one person gets addressed in the LLP mechanism.

Civil Construction – LLP facilitates joining in by landlord for sharing in profits without accessing project risks.

Taxability of LLP

• An LLP formed and registered under the LLP Act shall be taxed as a ‘firm’ under the Income-tax Act, 1961 [IT Act].

• LLP being a ‘firm’ would be liable to pay tax at the rate of 30% (plus EC and SHEC).

• From Assessment Year [AY] 2013-14, AMT is applicable to LLPs only if it has claimed any deduction u/s. 10AA or any section (other than section 80P) included in Chapter VI-A of IT Act

Some tax advantages to LLP compared to a company are as under:

‣ Non-applicability of Dividend Distribution Tax;

‣ Non-applicability of Wealth Tax;

‣ Non-applicability of Deemed dividend provisions u/s. 2(22)(e) of the IT Act;

‣ LLP can claim interest upto 12% on capital and borrowings from partners subject to conditions u/s. 40(b) of the IT Act, irrespective of profit or loss during the given year;

‣ Working partners of LLP are eligible for remuneration subject to conditions u/s. 40(b) of the IT Act;

‣ Immunity from Capital gain tax on conversion of private companies and unlisted public companies to LLP if the conditions u/s. 47(xiiib) are complied with.

Taxability in the hands of Partner of LLP

Share of total income

‣ Post-tax profits profits distributed amongst partners of LLP (including company) are exempt from tax u/s. 10(2A) of the IT Act. Further, in case of a company such profit is also eligible to be excluded in computation of book profit u/s. 115JB for MAT purposes.

Realignment of Profit sharing ratio [PSR]

‣ Realignment of PSR on admission of a new partner does not amount to ‘transfer’ u/s. 2(47) of the IT Act for capital gain purposes. This is because during the subsistence of partnership firm, partners do not have any defined share in the assets of the partnership.

Introduction of Capital Assets by a Partner

‣ Any capital asset brought in by a partner would be liable to tax in his hands in terms of section 45(3) of the IT Act. The amount at which such capital asset is to be credited in books is governed by Rule 23 of the LLP Rules. The said Rule provides that the capital asset shall be valued by a practicing Chartered Accountant / Cost Accountant / Approved Valuer.

Revaluation of Assets

‣ Revaluation of assets by LLP and credit of the revalued amount to the capital account of the partners does not entail to transfer u/s. 2(47) and so does not give rise to taxable capital gains. Further, such increased capital balances can be considered for calculating interest u/s. 40(b).

Conversion of Partnership Firm into LLP

Section 55 read with Schedule II provide for conversion of a partnership firm into LLP. A partnership firm can be converted into LLP:

a) if the partners of the LLP into which the firm is to be converted comprises all partners of the general partnership firm and no one else;

b) All property, assets, interests, rights, privileges, liabilities, obligations and undertaking of the general partnership firm are transferred to LLP in accordance with Schedule II.

If the above conditions are satisfied, the conversion shall not be regarded as transfer and consequently provisions relating to transfer of capital asset are not triggered.

Speed Breakers on conversion of a general partnership firm into LLP

Though LLP enjoys the benefits of limited liability over general partnership firm, yet one must consider the below speed breakers before deciding on conversion of a firm into LLP:

• For tax purposes, no special benefit is given to LLP compared to a Firm;

• LLP has more disclosure requirements and compliances as compared to a Firm;

• Annual Statement of accounts and Solvency and Annual Return is required to be filed with the Registrar of LLP every year;

• Cost of formation/conversion of LLP is higher;

• Heavy penalties suffered by LLP incase of delayed filings;

• More Government intervention as compared to a firm;

• Applicability of stamp duty on conversion of a Firm to LLP is prone to litigation;

• Difficult to dissolve or wind-up as compared to a partnership firm.

Conversion of private/unlisted Co. into LLP

Section 56 and 57 of the LLP Act read with Schedule III and IV provide for conversion of a private limited company and an unlisted public company respectively into LLP.

As per Schedule III and IV of the LLP Act, a private company and an unlisted public company may be converted into an LLP if the below conditions are fulfilled:

a) there is no security interest subsisting on the assets of the company at the time of application of conversion;

b) The partners of the LLP to which it converts consists of the shareholders of the company and no one else.

Further, to encourage certain companies to operate in LLP format section 47(xiiib) of the IT Act exempts the conversion subject to fulfilment of below mentioned conditions:

a) Eligibility criteria – Average annual total sales / turnover / gross receipts of the company does not exceed Rs. 60 lakhs in any 3 preceding previous years;

b) Conditions at Conversion stage

1. All shareholders of the company before conversion become partners of the LLP and Capital/ Profit Sharing ratio in the LLP should be in same proportion as their shareholding in the company;

2. Shareholders of the company receive no consideration, other than share in contribution and PSR in LLP;

3. All Assets / Liabilities of the Company are transferred to the LLP.

c) Conditions after Conversion

1. Erstwhile shareholders of the Company to retain atleast 50% PSR for 5 years from date of conversion;

2. No distribution of accumulated profits of the Company as on the date of conversion for 3 years from date of conversion.

If the above conditions are not satisfied then the provisions of section 47A(4) will apply and there will be capital gains tax in the hands of successor LLP / shareholder of predecessor company in the year in which any of the condition is violated.

Accumulated losses / unabsorbed depreciation of the erstwhile company available for set-off to successor LLP

As per section 72A(6A) of the IT Act, the accumulated business loss and unabsorbed depreciation of the predecessor company as on the date of conversion shall be allowed to c/f. And set off by he successor LLP if all the conditions u/s. 47(xiiib) are satisfied.

• MAT credit u/s. 115JAA not available to successor LLP

MAT credit of predecessor company shall not be available to successor LLP. Thus, the company may first avail MAT credit before converting to LLP. The provisions of section 115JAA(7) shall apply regardless of conversion in compliance with the conditions specified u/s. 47(xiiib) or not.

Speed breakers on conversion of a company into LLP

Though LLP enjoys the benefits of operational flexibility, lesser compliance and tax cost, yet one must consider the below speed breakers before deciding on conversion of a company into LLP:

• Raising money through public is not possible;

• Lesser creditworthiness as compared to a company;

• Heavy penalties suffered by LLP incase of delayed filings;

• Applicability of stamp duty on conversion of a Company to LLP is prone to litigation;

• No provision relating to redressal in case of oppression and mismanagement.

Conclusion:

The LLP form of business vehicle is gaining popularity as it is well addressing the issues of risk and succession for small businesses. However, Taxation of LLPs is an important issue to be considered both while forming new LLP or converting existing firms / private or unlisted companies into LLP especially in light of the conditions to be complied with over a period of 5 years.

For further queries, please feel free to contact at niyati.ca@gmail.com.