Tax planning with reference to new businesses and M&AUdisha AgarwalAnubhav MarwahAshish JainPrabhakaran Natraj

Tax Planning with reference to setting up a new business

When new business is formed or established, government provide benefits to the owners so that business may grow well. As per the income tax Act,1961 there are so many sections which is beneficial for the new business. These sections play an important role at the time of tax planning.Planning depends upon:- Nature and size of business- Location of business- Form of business organization- Capital structure

Location of businessTax planning is relevant for location point of view. There are certain locations which are given special tax treatment. Some of these are:

Fully exemption under Sec10AA for initial 5 years, 50% for subsequent 5 years and further deduction of 50% for a further period of 5 years in the case of newly established units in SEZ on or after 1.4.2005

Deduction under Sec80-IAB in respect of profits and gains by an undertaking or an enterprise engaged in the development of SEZ

Deduction under Sec80-IB in case of a newly set up industrial undertaking in a industrially backward state or district.

Deduction under Sec80-ID in respect of profits and gains from business of hotels and convention centers in specified areas or a hotel at world heritage site.

Deduction under Sec80-IE in respect of certain undertakings in North-Eastern states.

Nature of business

Tax planning is also relevant while deciding upon the nature of business. There are certain businesses which are given special tax treatment. Some of these are:

Tea, Coffee and Rubber Development Account under Sec 33AB

Special provisions in case of Shipping business under Sec 44BSpecial provisions in case of business of operation of business

crafts under Sec 44BBASpecial provisions in case of certain turnkey power projects

under Sec 44BBBSite restoration fund under Sec 33ABA

SPECIAL ECONOMIC ZONE [ SECTION 10AA]SPECIAL PROVISION IN RESPECT OF NEWLY ESTABLISHED UNITS IN SPECIAL ECONOMIC ZONE. The following conditions should be satisfied to claim deduction u/s 10AA : • Condition 1 : Assessee, being an entrepreneur as referred to in clause (j) of

section 2 of the Special Economic Zones Act, 2005. Entrepreneur is a person who has been granted a letter of approval by the Development Commissioner to set a unit in a Special Economic Zone.

• Conditions 2 : The Unit in Special Economic Zone who begins to manufacture or produce articles or things or provide any services during the previous year relevant to any assessment year commencing on or after the 1st day of April, 2006.

• Conditions 3 : It is not formed by the splitting up, or reconstruction, of a

business already an existence.

…• Conditions 4 : It not formed by the transfer to a new business,

of old plant and machinery. However, it can be formed by transfer of old plant or machinery to the extent of 20%.

• Condition 5 : The assessee has income from export of articles

or thing or from services from such unit. In other words, the assessee has exported goods or provided services out of India from the Special Economic Zone by land, sea , air, or by any other mode, whether physical or otherwise.

• Conditions 6 : Books of Accounts of the taxpayer should be

audited. The Tax payer should submit Audit Report in Form No.56F along with the return of income.

Amount of DeductionDeduction depends upon quantum of Profit derived from Export of Articles or things or services ( including computer software). It is calculated as under –

Profit of the Business of the undertaking X Export turnoverTotal Turnover of the business

Deduction for First 5 Assessment Years – 100% of Profits and Gains derived for a period of five consecutive assessment years beginning with the assessment year relevant to the previous year in which the Unit begins to manufacture or produce such articles or things or provide services.

Deduction for 6th Assessment Year to 10th Assessment Years : 50% of such Profits and Gains for further five assessment years and thereafter;

Deduction for 11th Assessment Year to 15th Assessment Year : Amount not exceeding 50% of the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is to be allowed and credited to a reserve account (to be called the “Special Economic Zone Re-investment Reserve Account”) to be created and utilized for the purposes of the business of the assessee.

Deduction in case of merger and demerger (Sec 10AA5)

Where any undertaking is transferred, before the expiry of the period specified in this section, to another undertaking, under a scheme of amalgamation or demerger,—• Deductions shall be allowable in the hands of the

amalgamated or the resulting company• No deduction shall be admissible under this section to

the amalgamating or the demerged Unit for the previous year in which the amalgamation or the demerger takes place

Provision illustrated:The following illustrations are given to explain the impact of aforesaid provisions –

X Ltd. owns an industrial undertaking in a notified special economic zone. It starts manufacturing on April 10, 2004. It can claim deduction under sections 10A and 10AA as follows –

First 5 years: For the assessment years 2005-06 to 2009-10, it can claim 100 per cent deduction under section 10A.

Next 5 years: For the next two assessment years, i.e., 2010-11 and 2014-15, it can claim 50 per cent deduction under section 10A.

Next 5 years: For the next five assessment years, i.e., 2015-16 to 2019-20, it can claim 50 per cent deduction (subject to an additional requirement of transferring an equivalent amount to Special Economic Zone Re-investment Reserve Account) under section 10AA(1)(ii).

Special Provisions In Respect Of Certain Undertakings Or Enterprises In Certain Special Category States [Sec. 80-IC]This section applies to any undertaking which fulfils all the following conditions, namely:- it is not formed by splitting up, or the reconstruction, of a business already

in existence it is not formed by the transfer to a new business of machinery or plant

previously used for any purpose Industrial Undertaking should be set up in certain special category of States. The Industrial Undertaking should manufacture / produce specified goods /

articles. Manufacture or production should be started within a stipulated time limit. Return of Income should be submitted on or before due date of submission

of return of income. The Books of Accounts of taxpayer should be audited and the Audit Report

in Form No-10CCB should be submitted along with the Return of Income.

INDUSTRIAL ZONES GIVEN UNDER SECTION 80-IC(2)

Following are the Industrial Zones notified by the Board for the relevant State :(i) “Industrial Area” means such areas, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government;(ii) “Industrial Estate” means such estates, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government;(iii) “Industrial Growth Centre” means such centres, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government;(iv) “Industrial Park” means such parks, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government;(v) “Integrated Infrastructure Development Centre” means such centres, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government;

(vi) “North-Eastern States” means the States of Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland and Tripura; (vii) “Software Technology Park” means any park set up in accordance with the Software Technology Park Scheme notified by the Government of India in the Ministry of Commerce and Industry;(viii) “substantial expansion” means increase in the investment in the plant and machinery by at least fifty per cent of the book value of plant and machinery (before taking depreciation in any year), as on the first day of the previous year in which the substantial expansion is undertaken;(ix) “Theme Park” means such parks, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government.

AMOUNT & PERIOD OF DEDUCTION

If the aforesaid conditions are satisfied , the deduction u/s 80 IC may be computed as under :

Tax planning for Hospitals• Constructed between 1/04/2008 to 31/03/2013.• At least 100 beds for patients.• Assesse submits an audit report in the prescribed form on

demand certifying that the deductions has been correctly claimed.

Deductions

A) Hospital located anywhere in India other than excluded area (Sec.80 –IB(11C)

• Business of operating and maintaining a hospital – 100% of such profits from GTI.

• The deduction shall be available for 5 assessment years, beginning from the initial year in which the undertaking begins to provide medical services.

Excluded areas• Greater Mumbai urban agglomeration• Delhi urban agglomeration…….so on…

B) Deduction regarding capital expenditureIf assesse incurs capital expenditure in respect of business of building and operating a new hospital anywhere in India , he will be entitles to deduct such expenditure from income of such business.

Contd…• Conditions:• Should be new business and not splitting up or reconstruction

of business.• Commenced after 31/03/2010.• Capital expenditure is incurred prior to the commencement of

its operations.• Amount is capitalized in the books of account on date of

commencement of operations.• If during previous year the expenses are more than the

receipts, the unabsorbed loss will be carried forward and set-off against income of such hospital or any other specific business.

Deduction under Section 80-IB[Section 80-IB(11C)• (11C) Amount of deduction in the case of an undertaking deriving

profits from the business, shall be 100 per cent of the profits and gains derived from such business for a period of five consecutive assessment years, beginning with the initial assessment year, if

• (i) the hospital is constructed and has started or starts functioning at any time during the period beginning on the 1st day of April, 2008 and ending on the 31st day of March, 2013;

• (ii) the hospital has at least 100 beds for patients;• (iii) the construction of the hospital is in accordance with the

regulations or bye-laws of the local authority; • (iv) the assesse furnishes along with the return of income, a report

of audit in such form and containing such particulars.

Hotel IndustryA) Hotel IndustryCondition Only to Indian Company Not formed by splitting up Not formed by transfer of old building Paid Up Capital is at least Rs. 5 Lac Hotel located in a hilly area / rural area / pilgrimage Approved by prescribed authority Deduction to specified & non specified hotels both.

Contd…• Condition for approval

Not more than 300 rooms of 3 star category. Place is specified Hilly Area means above 1000 mtrs from sea level;

Period of Deduction:• 100% of profit and gains derived from business for 5

consecutive assessment years for 10 years

B) Exception• Any machinery or plant which was used outside India by any

person other than the assesse shall not be regarded as machinery to plant previously used for any purpose if following conditions are full filled:

- such machinery or plant was not used in India before Installation by the assesse;- It is imported into India from outside India;

- NO depreciation has been allowed or allowable under this act for any period prior to installation of the P&M by the assesse.

C) An undertaking engaged in business hotel located in North eastern states

• If such hotel has started or starts functioning between 1.04.2007 and 31.03.2017

• Quantum and period of deduction:• -100% profits for 10 consecutive assessment years

D) Deduction regarding capital expenditureConditions:• Should be a new business• Should be commenced after 31.03.2010• The capital expenditure is incurred prior to the

commencement of operations.• CE shall not include expenditure incurred on acquisition on

land or goodwill or financial instrument.• The assesse shall get his accounts audited and submit the

report on demand by the A.O

Deductions

• (a) 50% of the profits and gains derived from the business of such hotel for a period of ten consecutive years beginning from during the period beginning on the 1st day of April, 1990 and ending on the 31st day of March, 1994 or beginning on the 1st day of April, 1997 and ending on the 31st day of March, 2001.

• Provided further that the said hotel is approved by the prescribed authority for the purpose of this clause in accordance with the rules made under this Act and where the said hotel is approved by the prescribed authority before the 31st day of March, 1992, shall be deemed to have been approved by the prescribed authority for the purpose of this section in relation to the assessment year commencing on the 1st day of April, 1991;

Contd…• (b) 30% of the profits and gains derived from the business of such

hotel as is located in any place other than those mentioned in sub-clause (a) for a period of ten consecutive years beginning from the initial assessment year .

• (c) the deduction under clause (a) or clause (b) shall be available only if,

• (i) the business of the hotel is not formed by the splitting up, or the reconstruction, of a business already in existence;

• (ii) the business of the hotel is owned and carried on by a company registered in India with a paid-up capital of not less than five hundred thousand rupees;

• (iii) the hotel is for the time being approved by the prescribed authority:

Amalgamation under Income-tax Act• According to Section 2(1B) of the ITA, "Amalgamation in relation to one or more companies

means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that:

1. All the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of amalgamation.

2. All the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of amalgamation.

3. Shareholders holding not less than three-fourths in value of the shares in the amalgamating company or companies (other than shares held therein immediately before the amalgamation or by a nominee for the amalgamated company or its subsidi-ary) become shareholders of the amalgamated company by virtue of the amalgamation otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of distribution of such property to the other company after the winding up of the first-mentioned company.

Merger which is not Amalgamation

• Amalgamation by virtue of Transaction of Sale - Where the property of company A is sold to other company B

• Amalgamation by virtue of Liquidation -Where the company A is wound-up in liquidation and the liquidator distributes the property of A to B

Provisions for carry forward and set off of accumulated lossesConditions to be fulfilled by Amalgamated company to carry forward the

unabsorbed depreciation and accumulated losses of the Amalgamating company:

• There should be Amalgamation of - • A company owning an Industrial Undertaking or Ship or Hotel with another

Company• A Banking company with a specified Bank• One or more Public Sector Company(s) engaged in the business of

operating Aircraft with one or more Public Sector Company(s) engaged in the similar business.

• The Amalgamating company has been engaged in the business, in which the accumulated losses occurred or depreciation remains unabsorbed, for 3 or more years.

• The amalgamating company has held continuously as on the date of Amalgamation at least 75% of the book value of fixed assets held by it two years prior to the date of Amalgamation.

Example

Assets and Book Value of company A as on 5.11.2009:

Assets carrying book value of atleast (75% of 200) = 150 Lakhs as on 5.11.2009 should be held on 5.11.2011

Assets Book Value in Lakhs

A 25

B 50

C 55

D 70

• The Amalgamated company holds continuously for a minimum period of 5 years from the date of Amalgamation at least 75% of the book value of fixed assets of the Amalgamating company.

• The Amalgamated company continues the business of the Amalgamating company for a period of 5 years from the date of Amalgamation.

• The Amalgamated company shall achieve the level of production or at least 50% of the installed capacity of the Amalgamating company before the end of 4th year and maintain the said level of production till the end of 5th year from the date of Amalgamation.

• Central Government may relax this condition of achieving the minimum level of production or the period during which the same is to be achieved in suitable cases having regard to the genuine efforts made to attain the prescribed level of production and the circumstances preventing such efforts from achieving the same.

• If these conditions are met then – • The Accumulated Losses of the Amalgamating company shall become

the Business Loss of the Amalgamated company for fresh 8 years. • The Unabsorbed Depreciation of the Amalgamating company shall

become the Unabsorbed Depreciation of the Amalgamated Company and can be carried forward indefinitely.

Consequences if the above conditions are not satisfied

• The set off of loss or allowance of depreciation made in any previous year in the hands of the Amalgamated company shall be deemed to be the income of the Amalgamated company chargeable to TAX for the year in which such conditions are not complied with.

• The Balance Accumulated Loss and Unabsorbed Depreciation not yet set off shall not be allowed to carry forward and set off.

Seller and Buyer perspective- Merger could be tax Neutral

Seller’s perspective • No tax for the amalgamating company or its share-holders. • Cost of acquisition for new shares received would be the same as the cost of

acquisition for shares held in amalgamating company. The period of holding of shares also to be reckoned from the time shares were held in amalgamating company.

Buyer’s perspective • Amalgamated entity can avail the tax benefit in relation to the accumulated losses and

the unabsorbed depreciation of the amalgamating company, in the previous year in which the amalgamation was effected, subject to prescribed conditions.

• Tax Benefits in the nature of tax incentive for export oriented units, expenditure for scientific research, acquisition of patent rights/copyrights, expenditure on prospecting for minerals and amortization of preliminary expenses pertaining to transferor company will be available to transferee company.

• Depreciation on assets – both intangible and tangible will be proportionately available to the transferor and transferee.

Tax concessions to the Amalgamating Company

• Any transfer of capital assets, in the scheme of amalgamation, by an amalgamating company to an Indian amalgamated company is not treated as transfer under section 47(vi) of the Act and so no capital gain tax is attracted in the hands of the amalgamating company.

• Tax Concession to a foreign Amalgamating Company [Section 47(via)]• In case the Amalgamating company is a foreign company having shares in

an Indian company, the transfer of such shares to another foreign Amalgamated company will not be regarded as transfer for the purpose of Capital Gain only if:• At least 25% of the shareholders of Amalgamating Foreign company

should continue to remain shareholders of Amalgamated Foreign company

• Such transfer does not attract TAX on Capital Gains in the country in which the Amalgamating company is incorporated.

Tax concessions to the Shareholders of an Amalgamating Company • When the shareholder of an amalgamating company transfers shares

held by him in the amalgamating company in consideration of allotment of shares in amalgamated company in the scheme of amalgamation, then such transfer of shares in not considered as transfer under section 47(vii) of the Act and consequently no capital gain is attracted in the hands of the shareholder of amalgamating company

• Where an Indian target entity is sought to be acquired by a foreign

entity, it may be noted that the corporate laws permit only domestic companies to be amalgamated. So the foreign acquirer have to create a local special purpose vehicle (SPV) in India to give effect the amalgamation with the Indian company and more over the SPV avails the tax benefits on amalgamation under the Act since the same are subject to the amalgamated company being an Indian company.

Tax concessions to the Amalgamated Company

• If the amalgamating company has incurred any expenditure eligible for deduction under sections (35(5), 35A(6),35AB(3), 35ABB, 35D, 35DD, 35DDA, 35E and/or 36(1)(ix)) prior to its amalgamation with the amalgamated company as per section 2(1B) of the Act and if the amalgamated company is an Indian company, then the benefit of the aforesaid sections shall be available to the amalgamated company, in the manner it would be available to the amalgamating company had there been no amalgamation.

• Under section 72A of the Act, the amalgamated company is entitled to carry for-ward the unabsorbed depreciation and unabsorbed accumulated business losses of the amalgamating company provided certain conditions are fulfilled

Expenditure on scientific research [section 35(5)]• Any unabsorbed capital expenditure on scientific research of the

Amalgamating company will be allowed to be carried forward and set off in the hands of the Amalgamated company.

• If such an asset ceases to be used in a previous year for scientific research related to the business of the Amalgamated company and is sold, the sale price, to the cost of asset will be treated as business income of the Amalgamated company and will be subjected to the provisions of the capital gains.

• Section 35ABB is applicable in case of Transfer or Sale of license by amalgamating company to the amalgamated company

• Expenditure on acquisition of telecom license(capital expenditure) is written off in equal installments.

• Transfer of license by amalgamating company, write off allowed to amalgamated company in the same manner as amalgamating company earlier.

• Write off shall be adjusted in case of sale of license by new company.

• Note – Spectrum Charges not akin to license fee. (MTNL vs CIT)

Expenditure for obtaining license to operate telecom services (Section 35ABB)

• Treatment of preliminary expenditure in case of a business organization U/S 35D

• Any capital expenditure done before the commencement of operation of specified business is allowable as deduction in 5 equal annual installments

• Only specified expenditure allowed:a) Expenditure for preparation of reportb) Legal charges for drafting agreements

• Incase of expansion of activities, preliminary expense is allowed• Determining Qualifying amount

Treatment of preliminary expense[section 35D)

Preliminary Expenditure in case of Amalgamation [section 35D95)

• The amount of preliminary expense of the Amalgamating company, which are not yet written-off, shall be allowed as deduction to the Amalgamated company in the same manner as would have been allowed to the Amalgamating company.

Amortization of expenditure[section 35DD]

• Where an assessee incurs any expenditure, wholly and exclusively for the purpose of Amalgamation or Demerger of an undertaking, the assessee shall be allowed a deduction of an amount equal to 1/5th of such expenditure for each of the five successive previous years beginning with the previous year in which Amalgamation or Demerger takes place.

Treatment of voluntary retirement expense [section 35DDA]

• When the undertaking of an Indian company, entitled to deduction for amortization of voluntary retirement expenses, is transferred before the expiry to another Indian company, in a scheme of Amalgamation, the deduction shall continue to be available to the Amalgamated company.

Treatment of expenditure on prospecting of certain minerals[section 35E(7A)]

• The amount of expenditure on prospecting, etc. of certain minerals of the Amalgamating company, which are not yet written off, shall be allowed as deduction to the Amalgamated company.

Treatment of Capital expenditure on family planning[section 36(1)(ix)]

• Businesses can claim deduction of capital expenditure on family planning for its employees in five equal installments.

• The capital expenditure on family planning not yet written off shall be allowable to the Amalgamated company in the same manner of balance installments.

• Treatment in case of sale of such assets will be same as would have been in the case of Amalgamating company.

• The debts of the Amalgamating company which were taken over by the Amalgamated company, becomes BAD and are allowed as a deduction to the Amalgamated company.

Treatment of bad debts[section 36(1)(vii)

SLUMP SALE• The term slump sale means transfer of one or more undertakings

by way of sale for a lump sum consideration, without values being assigned to the individual assets and liabilities.

• Any profit and gain arising from the slump sale in the previous year, is chargeable to income-tax as capital gains arising from the transfer of the undertaking.

• Where the undertaking is owned and held by the transferor for 36 months or less immediately preceding the transfer, the undertaking would be regarded as short-term capital asset and the gains taxed accordingly. In other cases, the undertaking would be regarded as a long-term capital asset even though such undertaking may have acquired certain assets which are held for less than 36 months58.

Demerger• A demerger is a reorganization of a company where the assets and

liabilities of an undertaking or part of an un-dertaking are transferred to one or more additional entities, viz. resulting companies.