Taxation of Companies

By Abhishek Kumar, CNLU

INTRODUCTION

Corporate Tax relates to the taxation of companies in India. For the purpose of taxation laws, a Company means:

  • An Indian company, or a corporate body incorporated inside or outside India.
  • Any institution, association or body whether incorporated or not, and whether domestic or non-resident, which is declared as a company by the Central Board of Direct Taxes (CBDT).

Income of a company

Before we head on to talking about what the rates of taxation for companies are, let’s take a look at what makes up the ‘income’ of a company. Generally, the income of a company falls under any of the following 4 heads of income:

  • Profits or gains from the business.
  • Income from property, whether it is housing, commercial, self-occupied or let-out. If the property is used in the company’s business operations, it does not fall under this head.
  • Capital gains.
  • Income from other sources including winnings from lotteries, races, and interest on securities.

The resultant figure is set off against any carried forward profits/loss which is then subject to deductions that are available under relevant headings. This net income is liable to income tax.

Domestic Company and Corporate Tax

A domestic company is a company formed and registered under the Companies Act 1956 or any other company which is liable to income tax. It can be either a private or public company. Here are some of the highlights of corporate taxation for domestic companies in India.

  • Domestic companies are subject to a flat rate of 30% as a corporate tax on their earnings.
  • If the company has a turnover of Rs. 1 crore or more, 5% surcharge is levied on the tax paid by the company.
  • 3% education cess is also payable.
  • Tax is levied on the global earnings of a domestic company, i.e. income from all sources is taxable.

Foreign companies and Corporate Tax

For the purpose of corporate taxation, a company whose control and management lies wholly outside India is a foreign company. It must also be noted that such companies should not have made arrangements to pay dividends within India. The taxation of foreign companies is not as straight-forward as that of a domestic company.

Taxation of foreign companies also depends on the taxation agreements between India and the country of the company. The withholding tax requirements, the DTAA, and other agreements should be kept in mind.

Just a few months before the recent Union Budget, there was a lot of talk of the corporate tax rate being reduced from the flat 30% to 25% for domestic companies? Well, that did not happen, however, 30% is on par with most other countries in the world.

TAXATION OF CORPORATE SECTOR

Company whether Indian or foreign is liable to taxation, under the Income Tax Act,1961. Corporation tax is a tax which is levied on the incomes of registered companies and corporations.

A Company means:-

  • Any Indian company, or
  • Any corporate body, incorporated by or under the laws of a country outside India, or
  • Any institution, association or a body which was assessed as a company for any assessment year under the Income Tax Act,1922 or was assessed under this Act as a company for any assessment year commencing on or before April 1, 1970, or
  • Any institution, association, or body, whether incorporated or not and whether Indian or Non-Indian, which is declared by a general or special order of the Central Board of Direct Taxes to be a company.

Companies in India, whether public or private are governed subject to the Companies Act, 1956 and of 2013. The registrar of companies and the company law board administers the provisions of the Act. However, for the purpose of taxation, companies are broadly classified as:-

Domestic company [Section 2(22A) of 1956 Act]:- means an Indian company (i.e. a company formed and registered under the Companies Act,1956) or any other company which, in respect of its income liable to tax, under the Income Tax Act, has made the prescribed arrangement for declaration and payments within India, of the dividends payable out of such income. A domestic company may be a public company or a private company.[i]

Foreign company [Section 2(23A)]:- means a company whose control and management are situated wholly outside India, and which has not made the prescribed arrangements for declaration and payment of dividends within India.[ii]

COMPUTATION OF TAXABLE INCOME OF A COMPANY 

Ascertain the ‘total income’ of the company by aggregating incomes falling under following four heads:-

  1. Income from House Property, whether residential or commercial, let-out or self-occupied. However, house property used for purpose of company’s business does not fall under this head.
  2. Profits and Gains of Business or Profession.
  3. Capital Gains.
  4. Income from other sources including interest on securities, winnings from lotteries, races, puzzles, etc.

Also, the income of other persons may be included in the income of the company. But, income under the head ‘Salary’ is not included under the company.

To the total income so obtained, ‘current and brought forward losses’ should be adjusted for set off in subsequent assessment years to arrive at the gross total Income. Thus the total income so computed is the ‘gross total income’. The ‘set off ‘ means, adjustment of certain losses against the incomes under other sources/heads (Section 79). This section applies to all losses including losses under the head ‘Capital Gains’.

Unabsorbed depreciation may be carried-forward for set-off indefinitely. But carryback of losses or depreciation is not permitted. However, business losses can be carried forward for eight consecutive financial years and can be set off against the profits of subsequent years.

From the gross total income, prescribed ‘deductions’ under Chapter VI A are made to get the ‘net income’.

Generally, all expenses incurred for business purposes are deductible from taxable income, given that the expenses must be wholly and exclusively incurred for business purposes and also that the expenses must be incurred/paid during the previous year and supported by relevant papers and records. But expenses of personal or of capital nature are not deductible.[iii]

Capital expenditure is deductible only through depreciation or as the basis of property in determining capital gains/losses. Deductions shall also be allowed in respect of depreciation, as per Section 32 of Income Tax Act, of tangible assets such as machinery, buildings, etc and non-tangible assets such as know-how, patents, etc, which are owned by the assessee and used for the purpose of the business/profession.

Depreciation is deducted from the written-down value of the block of assets mentioned under Section 43 of the Act. However, where an asset is acquired by the assessee during the previous year and is put to use for business/profession purpose for a period of fewer than 180 days, the deduction in respect of such assets shall be restricted to 50% of the normal value prescribed for all block of assets.

But no deduction shall be allowed in respect of any expenditure incurred in relation to income which does not form part of total income.

Tax liability is computed on the ‘net income’ that is chargeable to tax. It is done either on an accrual basis or on receipt basis (whichever is earlier). However, if an income is taxed on an accrual basis, it shall not be taxed on receipt basis.[iv]

From the tax so computed, tax rebates or tax credit are deducted.

DIFFERENT KINDS OF TAXES RELATING TO A COMPANY

Direct Taxes

In the case of direct taxes (income tax, wealth tax, etc.), the burden directly falls on the taxpayer.

Income tax

According to Income Tax Act 1961, every person, who is an assessee and whose total income exceeds the maximum exemption limit, shall be chargeable to the income tax at the rate or rates prescribed in the Finance Act. Such income tax shall be paid on the total income of the previous year in the relevant assessment year.[v]

Assessee means a person by whom (any tax) or any other sum of money is payable under the Income Tax Act, and includes –

(a) Every person in respect of whom any proceeding under the Income Tax Act has been taken for the assessment of his income (or assessment of fringe benefits) or of the income of any other person in respect of which he is assessable, or of the loss sustained by him or by such other person, or of the amount of refund due to him or to such other person;

(b) Every person who is deemed to be an assessee under any provisions of the Income Tax Act;

(c) Every person who is deemed to be an assessee in default under any provision of the Income Tax Act.[vi]

Where a person includes:

  • Individual
  • Hindu Undivided Family (HUF)
  • Association of persons (AOP)
  • A body of individuals (BOI)
  • Company
  • Firm
  • Local authority and,
  • Every artificial judicial person not falling within any of the preceding categories.

Income tax is an annual tax imposed separately for each assessment year (also called the tax year). Assessment year commences from 1st April and ends on the next 31st March.

The total income of an individual is determined on the basis of his residential status in India. For tax purposes, an individual may be resident, nonresident or not ordinarily resident.

Definition of a company

A company has been defined as a juristic person having an independent and separate legal entity from its shareholders. Income of the company is computed and assessed separately in the hands of the company. However, the income of the company, which is distributed to its shareholders as a dividend, is assessed in their individual hands. Such distribution of income is not treated as expenditure in the hands of the company; the income so distributed is an appropriation of the profits of the company.

Residence of a company

  • A company is said to be a resident in India during the relevant previous year if:
    • It is an Indian company.
    • If it is not an Indian company but, the control and the management of its affairs are situated wholly in India.
  • A company is said to be non-resident in India if it is not an Indian company and some part of the control and management of its affairs is situated outside India.[vii]

Corporate Sector Tax

The taxability of a company’s income depends on its domicile. Indian companies are taxable in India on their worldwide income. Foreign companies are taxable on income that arises out of their Indian operations, or, in certain cases, income that is deemed to arise in India.

Royalty, interest, gains from the sale of capital assets located in India (including gains from the sale of shares in an Indian company), dividends from Indian companies and fees for technical services are all treated as income arising in India.[viii]

Different kinds of taxes relating to a company

Minimum Alternative Tax (MAT)

Normally, a company is liable to pay tax on the income computed in accordance with the provisions of the income tax Act, but the profit and loss account of the company is prepared as per provisions of the Companies Act. There was a large number of companies who had book profits as per their profit and loss account but were not paying any tax because income computed as per provisions of the income tax act was either nil or negative or insignificant.

In such a case, although the companies were showing book profits and declaring dividends to the shareholders, they were not paying any income tax. These companies are popularly known as Zero Tax companies. In order to bring such companies under the income tax act net, Section 115JA was introduced w.e.f assessment year 1997-98.A new tax credit scheme is introduced by which MAT paid can be carried forward for set-off against regular tax payable during the subsequent five year period subject to certain conditions, as under:-

  • When a company pays tax under MAT, the tax credit earned by it shall be an amount, which is the difference between the amount payable under MAT and the regular tax. Regular tax, in this case, means the tax payable on the basis of normal computation of total income of the company.
  • MAT credit will be allowed to carry forward facility for a period of five assessment years immediately succeeding the assessment year in which MAT is paid. Unabsorbed MAT credit will be allowed to be accumulated subject to the five-year carry forward limit.
  • In the assessment year when the regular tax becomes payable, the difference between the regular tax and the tax computed under MAT for that year will be set off against the MAT credit available.
  • The credit allowed will not bear any interest.

Fringe Benefit Tax (FBT)

The Finance Act, 2005 introduced a new levy, namely Fringe Benefit Tax (FBT) contained in Chapter XIIH (Sections 115W to 115WL) of the Income Tax Act, 1961.

Fringe Benefit Tax (FBT) is an additional income tax payable by the employers on the value of fringe benefits provided or deemed to have been provided to the employees. The FBT is payable by an employer who is a company; a firm; an association of persons excluding trusts/a body of individuals; a local authority; a sole trader, or an artificial juridical person.

This tax is payable even where the employer does not otherwise have taxable income. Fringe Benefits are defined as any privilege, service, facility or amenity directly or indirectly provided by an employer to his employees (including former employees) by reason of their employment and include expenses or payments on certainly specified heads.

The benefit does not have to be provided directly in order to attract FBT. It may still be applied if the benefit is provided by a third party or an associate of an employer or by under an agreement with the employer.

The value of fringe benefits is computed as per provisions under Section 115WC. FBT is payable at the prescribed percentage on the taxable value of fringe benefits. Besides, a surcharge in case of both domestic and foreign companies shall be leviable on the amount of FBT.

On these amounts, education cess shall also be payable. Every company shall file the return of fringe benefits to the Assessing Officer in the prescribed form by 31st October of the assessment year as per provisions of Section 115WD. If the employer fails to file the return within a specified time limit specified under the said section, he will have to bear penalty as per Section 271FB.[ix]

The scope of Fringe Benefit Tax is being widened by including the employees stock option as fringe benefit liable for the tax. The fair market value of the share on the date of the vesting of the option by the employee as reduced by the amount actually paid by him or recovered from him shall be considered to be the fringe benefit. The fair market value shall be determined in accordance with the method to be prescribed by the CBDT.

Dividend Distribution Tax (DDT)

Under Section 115-O of the Income Tax Act, any amount declared, distributed or paid by a domestic company by way of dividend shall be chargeable to dividend tax. Only a domestic company (not a foreign company) is liable for the tax. Tax on distributed profit is in addition to income tax chargeable in respect of total income. It is applicable whether the dividend is interim or otherwise.

Also, it is applicable whether such dividend is paid out of current profits or accumulated profits. The tax shall be deposited within 14 days from the date of declaration, distribution or payment of dividend, whichever is earliest. Failing to this deposition will require payment of stipulated interest for every month of delay under Section 115-P of the Act.

The rate of dividend distribution tax to be raised from 12.5 percent to 15 percent on dividends distributed by companies, and to 25 percent on dividends paid by money market mutual funds and liquid mutual funds to all investors.

Banking Cash Transaction Tax (BCTT)

The Finance Act 2005 introduced the Banking Cash Transaction Tax (BCTT) w.e.f. June 1, 2005, and applies to the whole of India except in the state of Jammu and Kashmir.BCTT continues to be an extremely useful tool to track unaccounted monies and trace their source and destination. It has led the Income Tax Department to many money laundering and hawala transactions.

BCTT is levied at the rate of 0.1 percent of the value of following “taxable banking transactions” entered with any scheduled bank on any single day:

  • Withdrawal of cash from any bank account other than a saving bank account; and
  • Receipt of cash on encashment of term deposit(s).

However, the Banking Cash Transaction Tax (BCTT) has been withdrawn with effect from April 1, 2009.

Securities Transaction Tax (STT)

Securities Transaction Tax or turnover tax, as is generally known, is a tax that is leviable on taxable securities transaction. STT is leviable on the taxable securities transactions with effect from 1st October 2004 as per the notification issued by the Central Government. The surcharge is not leviable on the STT.

Wealth Tax

Wealth tax, in India, is levied under the Wealth-tax Act, 1957. Wealth tax is a tax on the benefits derived from property ownership. The tax is to be paid year after year on the same property on its market value, whether or not such property yields any income.

Under the Act, the tax is charged in respect of the wealth held during the assessment year by the following persons: –

  • Individual
  • Hindu Undivided Family (HUF)
  • Company

Chargeability to tax also depends upon the residential status of the assessee same as the residential status for the purpose of the Income Tax Act.

Wealth tax is not levied on productive assets, hence investments in shares, debentures, UTI, mutual funds, etc are exempt from it. The assets chargeable to wealth tax are the guest house, residential house, commercial building, motor car, jewelry, bullion, utensils of gold, silver, yachts, boats, and aircraft, urban land and cash in hand (in excess of Rs 50,000 for Individual & HUF only).

The following will not be included in Assets: –

  • Assets held as Stock in trade.
  • A house held for business or profession.
  • Any property in nature of the commercial complex.
  • A house let out for more than 300 days in a year.
  • Gold deposit bond.
  • A residential house allotted by a Company to an employee, or an Officer, or a Whole Time Director (Gross salary i.e. excluding perquisites and before Standard Deduction of such Employee, Officer, Director should be less than Rs 5,00,000).

The assets exempt from Wealth tax are “Property held under a trust”, Interest of the assessee in the coparcenary property of a HUF of which he is a member, “Residential building of a former ruler”, “Assets belonging to Indian repatriates”, one house or a part of house or a plot of land not exceeding 500sq.mt (for individual & HUF assessee).

Wealth tax is chargeable in respect of Net wealth corresponding to Valuation date where Net wealth is all assets fewer loans taken to acquire those assets and valuation date is 31st March of immediately preceding the assessment year. In other words, the value of the taxable assets on the valuation date is clubbed together and is reduced by the amount of debt owed by the assessee. The net wealth so arrived at is charged to tax at the specified rates. Wealth tax is charged at 1 percent of the amount by which the net wealth exceeds Rs 15 Lakhs.[x]

Indirect Taxation

Sales tax

Central Sales Tax (CST)

Central Sales tax is generally payable on the sale of all goods by a dealer in the course of inter-state trade or commerce or, outside a state or, in the course of import into or, export from India.

The ceiling rate on central sales tax (CST), a tax on the inter-state sale of goods, has been reduced from 4 percent to 3 percent in the current year.

Value Added Tax (VAT)

VAT is a multi-stage tax on goods that is levied across various stages of production and supply with credit given for tax paid at each stage of Value addition. Introduction of state-level VAT is the most significant tax reform measure at the state level. The state level VAT has replaced the existing State Sales Tax.[xi] The decision to implement State level VAT was taken in the meeting of the Empowered Committee (EC) of State Finance Ministers held on June 18, 2004, where a broad consensus was arrived at to introduce VAT from April 1, 2005. Accordingly, all states/UTs have implemented VAT.

The Empowered Committee, through its deliberations over the years, finalized design of VAT to be adopted by the States, which seeks to retain the essential features of VAT, while at the same time, providing a measure of flexibility to the States, to enable them to meet their local requirements. Some salient features of the VAT design finalized by the Empowered Committee are as follows:

  • The rates of VAT on various commodities shall be uniform for all the States/UTs. There are 2 basic rates of 4 percent and 12.5 percent, besides an exempt category and a special rate of 1 percent for a few selected items. The items of basic necessities have been put in the zero rate bracket or the exempted schedule.

Gold, silver and precious stones have been put in the 1 percent schedule. There is also a category with 20 percent floor rate of tax, but the commodities listed in this schedule are not eligible for input tax rebate/set off. This category covers items like motor spirit (petrol), diesel, aviation turbine fuel, and liquor.

  • There is provision for eliminating the multiplicity of taxes. In fact, all the State taxes on purchase or sale of goods (excluding Entry Tax in lieu of Octroi) are required to be subsumed in VAT or made VATable.
  • Provision has been made for allowing “Input Tax Credit (ITC)”, which is the basic feature of VAT. However, since the VAT being implemented is intra-State VAT only and does not cover inter-State sale transactions, ITC will not be available on inter-State purchases.
  • Exports will be zero-rated, with credit given for all taxes on inputs/ purchases related to such exports.
  • There are provisions to make the system more business-friendly. For instance, there is a provision for self-assessment by the dealers. Similarly, there is a provision of a threshold limit for registration of dealers in terms of annual turnover of Rs 5 lakh. Dealers with turnover lower than this threshold limit are not required to obtain registration under VAT and are exempt from payment of VAT. There is also provision for the composition of tax liability up to an annual turnover limit of Rs. 50 lakh.
  • Regarding the industrial incentives, the States have been allowed to continue with the existing incentives, without breaking the VAT chain. However, no fresh sales tax/VAT based incentives are permitted.[xii]

Roadmap towards GST

The Empowered Committee of State Finance Ministers has been entrusted with the task of preparing a roadmap for the introduction of national level goods and services tax with effect from 01 April 2007. The move is towards the reduction of CST to 2 percent in 2008, 1 percent in 2009 and 0 percent in 2010 to pave way for the introduction of GST (Goods and Services Tax).

Excise Duty

Central Excise duty is an indirect tax levied on goods manufactured in India. Excisable goods have been defined as those, which have been specified in the Central Excise Tariff Act as being subjected to the duty of excise.

There are three types of Central Excise duties collected in India namely:

Basic Excise Duty

This is the duty charged under section 3 of the Central Excises and Salt Act,1944 on all excisable goods other than salt which are produced or manufactured in India at the rates set forth in the schedule to the Central Excise tariff Act,1985.

Additional Duty of Excise

Section 3 of the Additional duties of Excise (goods of special importance) Act, 1957 authorizes the levy and collection in respect of the goods described in the Schedule to this Act. This is levied in lieu of sales Tax and shared between Central and State Governments. These are levied under different enactments like medicinal and toilet preparations, sugar etc. and other industries development etc.

Special Excise Duty

As per the Section 37 of the Finance Act,1978 Special excise Duty was attracted on all excisable goods on which there is a levy of Basic excise Duty under the Central Excises and Salt Act,1944. Since then each year the relevant provisions of the Finance Act specifies that the Special Excise Duty shall be or shall not be levied and collected during the relevant financial year.

Customs Duty

Custom or import duties are levied by the Central Government of India on the goods imported into India. The rate at which customs duty is leviable on the goods depends on the classification of the goods determined under the Customs Tariff. The Customs Tariff is generally aligned with the Harmonised System of Nomenclature (HSL).

In line with aligning the customs duty and bringing it at par with the ASEAN level, the government has reduced the peak customs duty from 12.5 percent to 10 percent for all goods other than agriculture products. However, the Central Government has the power to generally exempt goods of any specified description from the whole or any part of the duties of customs leviable thereon. In addition, preferential/concessional rates of duty are also available under the various Trade Agreements.

Service Tax

Service tax was introduced in India way back in 1994 and started with mere 3 basic services viz. general insurance, stock broking, and telephone. Today the counter services subject to tax have reached over 100. There has been a steady increase in the rate of service tax. From a mere 5 percent, service tax is now levied on specified taxable services at the rate of 12 percent of the gross value of taxable services. However, on account of the imposition of education cess of 3 percent, the effective rate of service tax is at 12.36 percent.[xiii]

TAX REBATES FOR CORPORATE TAX

The classical system of corporate taxation is followed in India:

  • Domestic companies are permitted to deduct dividends received from other domestic companies in certain cases.
  • Inter Company transactions are honored if negotiated at arm’s length.
  • Special provisions apply to venture funds and venture capital companies.
  • Long-term capital gains have lower tax incidence.
  • There is no concept of thin capitalization.
  • Liberal deductions are allowed for exports and the set up on new industrial undertakings under certain circumstances.
  • There are liberal deductions for setting up enterprises engaged in developing, maintaining and operating new infrastructure facilities and power-generating units.
  • Business losses can be carried forward for eight years, and unabsorbed depreciation can be carried indefinitely. No carry back is allowed.
  • Dividends, interest and long-term capital gain income earned by an infrastructure fund or company from investments in shares or long-term finance in enterprises carrying on the business of developing, monitoring and operating specified infrastructure facilities or in units of mutual funds involved with the infrastructure of the power sector are proposed to be tax exempt.[xiv]

Capital Gains Tax

A capital gain is an income derived from the sale of an investment. Capital investment can be a home, a farm, a ranch, a family business, work of art etc. In most years slightly less than half of taxable capital gains are realized on the sale of corporate stock. The capital gain is the difference between the money received from selling the asset and the price paid for it.

Capital gain also includes gain that arises on “transfer” (includes sale, exchange) of a capital asset and is categorized into short-term gains and long-term gains.

The capital gains tax is different from almost all other forms of taxation in that it is a voluntary tax. Since the tax is paid only when an asset is sold, taxpayers can legally avoid payment by holding on to their assets–a phenomenon known as the “lock-in effect.”

The scope of a capital asset is being widened by including certain items held as personal effects such as archaeological collections, drawings, paintings, sculptures or any work of art. Presently no capital gain tax is payable in respect of the transfer of personal effects as it does not fall in the definition of the capital asset. To restrict the misuse of this provision, the definition of a capital asset is being widened to include those personal effects such as archaeological collections, drawings, paintings, sculptures or any work of art. Transfer of above items shall now attract capital gain tax the way jewelry attracts despite being personal effect as on date.

Short Term and Long Term Capital Gains

Gains arising on transfer of a capital asset held for not more than 36 months (12 months in the case of a share held in a company or other security listed on recognized stock exchange in India or a unit of a mutual fund) prior to its transfer are “short-term”. Capital gains arising on transfer of capital asset held for a period exceeding the aforesaid period are “long-term”.

Section 112 of the Income-Tax Act, provides for the tax on long-term capital gains, at 20 percent of the gain computed with the benefit of indexation and 10 percent of the gain computed (in case of listed securities or units) without the benefit of indexation.[xv]

Double Taxation Relief

Double Taxation means taxation of the same income of a person in more than one country. This results due to countries following different rules for income taxation. There are two main rules of income taxation i.e. (a) Source of income rule and (b) residence rule.

As per source of income rule, the income may be subject to tax in the country where the source of such income exists (i.e. where the business establishment is situated or where the asset/property is located) whether the income earner is a resident in that country or not.

On the other hand, the income earner may be taxed on the basis of the residential status in that country. For example, if a person is a resident of a country, he may have to pay tax on any income earned outside that country as well. Further, some countries may follow a mixture of the above two rules.

Thus, the problem of double taxation arises if a person is taxed in respect of any income on the basis of source of income rule in one country and on the basis of residence in another country or on the basis of a mixture of above two rules. In India, the liability under the Income Tax Act arises on the basis of the residential status of the assessee during the previous year. In case the assessee is resident in India, he also has to pay tax on the income, which accrues or arises outside India, and also received outside India.

The position in many other countries is also broadly similar, it frequently happens that a person may be found to be a resident in more than one country or that the same item of his income may be treated as accruing, arising or received in more than one country with the result that the same item becomes liable to tax in more than one country. Relief against such hardship can be provided mainly in two ways: (a) Bilateral relief, (b) Unilateral relief.

Bilateral Relief

The Governments of two countries can enter into Double Taxation Avoidance Agreement (DTAA) to provide relief against such Double Taxation, worked out on the basis of mutual agreement between the two concerned sovereign states. This may be called a scheme of ‘bilateral relief’ as both concerned powers agree as to the basis of the relief to be granted by either of them.

Unilateral relief

The above procedure for granting relief will not be sufficient to meet all cases. No country will be in a position to arrive at such an agreement with all the countries of the world for all time. The hardship of the taxpayer, however, is a crippling one in all such cases. Some relief can be provided even in such cases by home country irrespective of whether the other country concerned has any agreement with India or has otherwise provided for any relief at all in respect of such double taxation. This relief is known as unilateral relief.[xvi]

PROVISION RELATING TO TAXATION OF A COMPANY

Indian companies are taxable in India on their worldwide income, irrespective of its source and origin. Foreign companies are taxed only on income which arises from operations carried out in India or, in certain cases, on income which is deemed to have arisen in India. The later includes royalty, fees for technical services, interest, gains from the sale of capital assets situated in India (including gains from the sale of shares in an Indian company) and dividends from Indian companies. Thus, the tax liability on the income of a company depends upon the residential status of the company.

A Company is said to be resident in India during any relevant previous year if:-

  • It is an Indian Company; or
  • The control and management of its affairs are situated wholly in India. In the case of Resident Companies, the total income liable to tax includes [Section 5(1)]:-
    • Any income which is received or is deemed to be received in India in the relevant previous year by or on behalf of such company.
    • Any income which accrues or arises or is deemed to accrue or arise in India during the relevant previous year.
    • Any income which accrues or arises outside India during the relevant previous year.

Similarly, a Company is said to be non-resident during any relevant previous year if:-

  • It is not an Indian company, and
  • The control and management of its affairs are situated wholly/partially outside India. In the case of Non-Resident Companies, the total income liable to tax includes [Section 5(2)]:-
    • Any income which is received or is deemed to be received in India during the relevant previous year by or on behalf of such company.
    • Any income which accrues or arises or is deemed to accrue or arise to it in India during the relevant previous year.[xvii]

As a result, a situation may arise where the same income becomes taxable in the hands of the same company in one or more countries, leading to ‘Double Taxation’.[xviii]

The problem of double taxation may arise on account of any of the following reasons:-

  • A company (or a person) may be resident of one country but may derive income from another country as well, thus he becomes taxable in both the countries.
  • A company/person may be subjected to tax on his world income in two or more countries, which is known as the concurrent full liability to tax. One country may tax on the basis of the nationality of tax-payer and another on the basis of his residence within its border. Thus, a person domiciled in one country and residing in another may become liable to tax in both the countries in respect of his world income.
  • A company/person who is non-resident in both the countries may be subjected to tax in each one of them on income derived from one of them, for example, a non-resident person has a Permanent establishment in one country and through it, he derives income from the other country.[xix]

In India, the relief against double taxation has been provided under Section 90 and Section 91 of the Income Tax Act.

Section 90 of the Income Tax Act relates to bilateral relief. Under it, the Central Government has entered into an agreement with the Government of any country outside India. These agreements called as “double taxation avoidance agreements (DTAA’s)”, provides for the following:-

Granting of relief in respect of:-

  • Income on which income tax has been paid both in India and in that country or
  • Income tax chargeable in India and under the corresponding law in force in that country to promote mutual economic relations, trade, and investment, or
  • The type of income which shall be chargeable to tax in either country so that there is avoidance of double taxation of income under this Act and under the corresponding law in force in that country.

In addition, the Central Government may enter into an agreement to provide:-

  • For exchange of information for the prevention of evasion or avoidance of income tax chargeable under the Act or under the corresponding law in force in that country or investigation of cases of such evasion or avoidance, or
  • For recovery of income tax under the Act and under the corresponding law in force in that country.[xx]

India has entered into DTAA with 65 countries including countries like U.S.A., U.K., Japan, France, Germany, etc. In the case of countries with which India has double taxation avoidance agreements, the tax rates are determined by such agreements.

Under the section, the assessee is given relief by credit/refund in a particular manner even though he is taxed in both the countries.

Relief may be in the form of credit for tax payable in another country or by charging tax at a lower rate. The steps involved in granting such a bilateral relief are:-

(a) Compute the total income of person liable to pay tax in India in accordance with the provisions of the Income Tax Act.

(b) Allow relief as per the terms of the tax treaty entered into with the other contracting company, where the taxation has suffered double taxation. The liabilities to tax arising under the Income Tax Act are subject to provisions of the double taxation avoidance agreements between India and a foreign country. Thus the treaty provisions shall prevail over the income tax provisions.

The types of agreements under DTAA’s can be majorly categorized as:-

  • Comprehensive Agreements:-These are elaborated documents which put forward in detail that how incomes under various heads may be dealt with.
  • Limited Agreements: -These are entered into to avoid double taxation related to the income derived from the operation of aircraft, ships, carriage of cargo and freight.
  • Other Agreements: -including double taxation relief rules.

Section 91 of the Income Tax Act relates to unilateral relief. Under it, if any person/company is resident in India in any previous year and paid the income, which accrued to him in India, to any country with which there is no agreement (under Section 90) for relief from double taxation, he shall be entitled to deduction from the Indian Income-tax payable by him of a sum calculated on such doubly taxed income at the average Indian rate of tax or the average rate of tax of said country, whichever is lower, or at the Indian rate of tax if both the rates are equal.

The steps involved in calculating relief under this section are:-

(a)Calculate tax on total income(including foreign income) and claim relief applicable on it.

(b)Add surcharge and education cess after claiming rebate under the Section 88E.

(c)Compute the average rate of tax by dividing the tax computed in the previous step with the total income.

(d)calculate the average rate of tax of foreign country by dividing income-tax actually paid in the said country after deduction of all relief due.

(e)Claim the relief from the tax payable in India at the rate computed in the previous two steps on the basis of whichever is less.[xxi]

CASE LAWS

Narottam and Parekh Ltd. v. C.I.T[xxii]

The question for consideration in this appeal was whether the assessee company is a resident company.

Facts.

The company is a subsidiary company of the Scindia Steam Navigation Co. Ltd. and its business is stevedoring in Ceylon. It is registered in Bombay and its registered office is also in Bombay. The meetings of the Board of Directors are held in Bombay and also the meetings of the shareholders.

Section 6 (3) (c) tells us that in the eye of the law is a residence with regard to a company.

In order that a company’s income should be subjected to tax as a resident, it has got to be established that the control and management of its affairs are situated wholly in the taxable territories in India.

“Control and management” is a compendious expression which has acquired a definite significance and connotation. It is also necessary that the control and management of the affairs of the company should be situated wholly in the taxable territories in India.

Therefore, if any part of the control and management is outside the taxable territories in India, then the company would not be resident.

In this connection, it is pertinent to look at the converse definition of a Hindu undivided family, firm or other association of persons.

In their case, they are resident unless the control and management of its affairs are situated wholly outside the taxable territories.

In construing the expression “control and management” it is necessary to bear in mind the distinction between doing of business and the control and management of the business. Business and the whole of it may be done outside India and yet the control and management of that business may be wholly within India.

The contention of the Appellant.

The whole of the business of the company is done in Ceylon and the whole of the income which is liable to tax has been earned in Ceylon.

Secondly, the affairs of the company in Ceylon are managed by managers having power of attorney to do any act. This power of attorney effectively vests control of the company in managers residing in Ceylon.

The reasoning of the Court.

The legislative intent is not about the place of business of earnings which is accruing to the company.

It is entirely irrelevant where the business is done and where the income has been earned.

 “Control and management” referred to in S. 6 point out the central control and management.

The control and management contemplated by this section is not the carrying on of day to day business by servants, employees or agents.

It is that authority to which the servants, employees, and agents are subject, it is that authority which controls and manages them, which is the central authority, and it is at the place where the central authority functions that the company resides.

It may be in some cases that, like an individual, a company may have a residence in more than one place. It may exercise control and management not only from one fixed abode, but it may have different places.

That would again be a question dependent upon the circumstances of each case.

But the contention which is entirely unacceptable that a company controls or manages at a particular place because its affairs are carried on at a particular place and they are carried on by people living there appointed by the company with large powers of management.

In the present case, two managers under two powers of attorney look after all the affairs of the assessee company in Ceylon. The widest possible power and authority has been conferred upon these two managers under this power-of-attorney.

But it is equally clear from the minutes of the meetings of the Board of Directors which are also before us that the central management and control has been kept in Bombay and has been exercised by the directors in Bombay.

The minutes deal with various matters which are delegated to these two managers and yet the directors from a proper sense of responsibility to the company have retained complete control over these matters and have from time to time given directions to the managers as to how things should be done and managed.

What we have to consider in this case is not the power or the capacity to manage and control, but the actual control and management, or in other words, not the ‘de jure’ control and management but the ‘de facto’ control and management, and in order to hold that the company is resident during the years of account, it must be established that the company ‘de facto’ controlled and managed its affairs in Bombay.

Four principles which were enunciated in Swedish Central Railway Company Limited v. Thompson[xxiii], were laid down, in this case, to determine residence for taxation purposes.

The four principles are:

(1) Control and management signifies in the present context, the controlling and directive power, the head and brain as it is sometimes called, and situated implies the functioning of such power at a particular place with some degree of permanence, while wholly would seem to recognise the possibility of the seat of such power being divided between two distinct and separate places.

(2) Mere activity by the company in a place does not create residence.

(3)  The central management and control of a company may be divided, and it may keep house and do business in more than one place.

(4) In the case of dual residence, there may be two centers of management.

But the important principle which applies to the present case is the one that has been first set out and which emphasizes the fact that what we have to consider in order to determine the residence of a company is as to where its head and brain is, and the head and brain of the company will be where its controlling and directive power functions.

Secondly, we take it that the word ‘affairs’ must mean affairs which are relevant for the purpose of the Income-tax Act and which have some relation to income.

It is not any business that the company does which has got to be considered.

In order to determine the head and brain of the company, we are not to concern ourselves with any other work that the company does except its business which yields profits.

 In this particular case, we have got to consider where the head and brain of the company is with regard to the stevedoring business in Ceylon which has yielded the income.

Applying that test, the only logical conclusion is that the head and brain of the company with regard to this particular business or with regard to its affairs was in Bombay and not in Ceylon.

Therefore the assessee company is resident in India for the purpose of Income Tax act as its affairs are managed by persons who are based in India and not in Ceylon. The fact that the affairs of the company are being managed by managers independently in Ceylon is of no consequence for determining the question of residence as effective control is situated in India.

Bhimji Naik v. Commissioner of Income-tax, Bombay[xxiv]

The question, in this case, was whether the control and management, as contemplated under Section 6  was a ‘de facto’ or a ‘de jure’ control.

In that case, one Mr. Naik carried on business in South Africa.

In 1912 he returned to India leaving his business in the hands of three managers.

In 1937 he executed a partnership deed by which he admitted these three managers as partners.

Under the partnership deed, he retained to himself the full control of the business and even the right to dismiss any of the three partners.

The Income Tax Appellate Tribunal found that the firm was resident in British India as the legal right to control and manage vested in Naik and he was resident in British India and it was not shown that he had not exercised any control in the management of company affairs.

On appeal, the High Court drew a distinction between the case of a partner and the case of an agent or an employee.

Since the business was being managed by the partners of Naik in South Africa, the question of ‘de facto’ management had to be considered.

It was held that the question whether the assessee is resident within the meaning of S. 6  is a question of fact.

It was stated that :

“As it is difficult to apply the test of physical residence to an association of persons or a firm, the test is held to be: where the central control and management actually abides.  The expression “control and management” means where the central control and management actually abides, and not where the business of the company is carried on by persons appointed by the company.”

Talipatigala Estate v. Commr.of Income Tax[xxv]

In this case affairs of a rubber estate in Ceylon was managed by the assessee firm consisting of two partners, one of whom was resident in British India, and the estate was managed by an agent holding a power-of-attorney from the partners.

The question for consideration was whether the assessee firm had any part of the control and management within British India.

The Court was concerned to determine whether any part of the control and management was within British India and notwithstanding the fact that the rubber estate was managed by an agent holding a power-of-attorney, it was found that there was the exercise of control and management by the partners from British India.

It was held that not only the right to exercise control and management over the firm’s affairs in Ceylon vested with the partner resident in British India but some amount of control and management of the firm’s affairs was actually exercised in British India and the assessee firm was therefore resident in British India within the meaning of S. 6.

CONCLUSION

India has a well-developed tax structure with clearly demarcated authority between Central and State Governments and local bodies.

Central Government levies taxes on income (except the tax on agricultural income, which the State Governments can levy), customs duties, central excise and service tax.

Value Added Tax (VAT), stamp duty, state excise, land revenue, and profession tax are levied by the State Governments.

Local bodies are empowered to levy a tax on properties, octroi and for utilities like water supply, drainage etc.

All companies whether Indian or foreign are liable to tax, irrespective of the quantum of income. However, for the purpose of ¬ taxation, companies are broadly classified as under:

(a) The domestic company in which public are substantially interested i.e., Public Company

(b) Domestic company in which the public is not substantial. interested, i.e., Private Company.

(c) Foreign Company which has not made the prescribed arrangement: for declaration and payment of dividends within India.

The taxable income of companies is computed in the same manner as for other non-corporate assessees. The income is computed separately under each head and then aggregated to compute the gross total income. A company, however, can have no income under the head ‘Salary’ for obvious reasons.

Indian companies are taxable in India on their worldwide income, irrespective of its source and origin. Foreign companies are taxed only on income which arises from operations carried out in India or, in certain cases, on income which is deemed to have arisen in India. The later includes royalty, fees for technical services, interest, gains from the sale of capital assets situated in India (including gains from the sale of shares in an Indian company) and dividends from Indian companies. Thus, the tax liability on the income of a company depends upon the residential status of the company.

The liabilities to tax arising under the Income Tax Act are subject to provisions of the double taxation avoidance agreements between India and a foreign country. Thus the treaty provisions shall prevail over the income tax provisions.

Indian taxation system has undergone tremendous reforms during the last decade. The tax rates have been rationalized and tax laws have been simplified resulting in better compliance, ease of tax payment and better enforcement. The process of rationalization of tax administration is ongoing in India.

Formatted on February 20th, 2019.

REFERENCES:

[i]http://incometaxmanagement.com/Pages/Taxation-Companies/Types-Of-Company.htmlas accessed on 25th Oct, 14.

[ii] ibid

[iii]http://business.gov.in/taxation/computation_income.php as accessed on 25th Oct, 2014.

[iv] ibid

[v]http://business.gov.in/taxation/different_taxes.phpas accessed on 25th Oct, 14.

[vi]http://www.lawnotes.in/Section_2_of_Income-Tax_Act,_1961 as accessed on 25th Oct, 14.

[vii]Dr. Singhania, K. Vinod and Dr. Monica Singhania, “Student’s Guide to Income Tax”, Taxmann Publications, 49th edition.Pg. no. 79.

[viii] Supra Note 5.

[ix]http://incometaxmanagement.com/Pages/Tax-Management-Procedure/7-Fringe-Benefit-Tax-FBT.html as accessed on 25th Oct, 14.

[x]http://business.gov.in/taxation/wealth_tax.php as accessed on 25th Oct, 14.

[xi]http://indiainbusiness.nic.in/newdesign/index.php?param=investment_landing/293/6 as accessed on 25th Oct, 14.

[xii]Dr. Singhania, K. Vinod and Dr. Monica Singhania, “Student’s Guide to Income Tax”, Taxmann Publications, 49th edition.Pg. no. 872.

[xiii]Dr. Singhania, K. Vinod and Dr. Monica Singhania, “Student’s Guide to Income Tax”, Taxmann Publications, 49th edition.Pg. no. 794.

[xiv]http://indiainbusiness.nic.in/newdesign/index.php?param=investment_landing/293/6 as accessed on 25th Oct, 14

[xv] Ibid

[xvi]Dr. Singhania, K. Vinod and Dr. Monica Singhania, “Student’s Guide to Income Tax”, Taxmann Publications, 49th edition.Pg. no. 704.

[xvii]http://business.gov.in/taxation/taxation_company.php as accessed on 25th Oct, 14

[xviii]http://www.britannica.com/EBchecked/topic/584564/tax-law/71935/Double-taxation as accessed on 25th Oct, 14.

[xix]http://www.taxanalysts.com/www/features.nsf/Features/E6E987F4B72389EA85257C7C0050EE52?OpenDocument.

[xx] Supra Note 9.

[xxi] ibid

[xxii]AIR 1954 Bom 67

[xxiii][(1925) 9 Tax Cas 342]

[xxiv][AIR 1945 Bom. 271].

[xxv][AIR 1950 Mad.781].

4 Replies to “Taxation of Companies”

  1. A foreign Company Holds 99.99% in the company which is registered in India under Companies act 2013 , Whether it can be taxable as foreign company under Income Tax Act or what is the scenario.?
    Can you please come back with master reply.

  2. Hlo sir, i have a question that if a assesse has own property and thr same is given by him to the partnership firm, in which he is a partner for carryinf on the bussiness of such firm then the income form such property will taxable under where and why?? Sir pls give me the ans

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