How Beneficial are Lower tax rates for domestic companies?

The Government has brought in the Taxation Laws (Amendment) Ordinance 2019 to make certain amendments in the Income – Tax Act 1961 (‘the Act’) and the Finance Act 2019.  In her speech, introducing the amendment, the Finance Minister – Ms. Nirmala Sitharaman stated that this initiative was brought about with an objective to promote growth and investment and also to attract fresh investments in manufacturing and thereby provide a boost to the ‘Make – in – India’ initiative of the Government.

The Ordinance  amended the Act and the Finance (No. 2) Act, 2019. s. 115BAA and s. 115BAB have been newly inserted in Act.  Under these sections, domestic companies have been provided an option to opt for lower tax rates, subject to certain conditions.

How beneficial are the new provisions of s. 115BAA? The domestic companies would have to forgo certain  deductions in order to take the benefit of the lowered tax rates, however, would such a lowered tax rate actually assist such companies in the long run by reducing the outflow of funds by way of taxes?

Let’s find out.

The difference between the tax structure under the existing provisions and the newly introduced s. 115BAA are hereby enunciated here below :

s. 115BAA is applicable to domestic companies not covered under s. 115BA and s. 115BAB of the Act. An assesse company would be eligible to pay taxes under s. 115BAA on fulfilment of certain conditions :

  1. Such a company shall not be entitled to deduction under s. 10AA, 32(1)(iia), 32AC, 32AD, 33AB, 35(1)(ii), (iia), (iii), (2AA), 2(AB), 35AC, 35AD, 35CCC, 35CCD, as well as under Chapter VIA PART C (excluding s. 80JJA);
  2. Such company will not be entitled to claim set off of loss carried forward from earlier years if the same is attributed to the above deductions. Such loss carried forward loss shall be deemed to have been allowed and will not be allowed in any subsequent year.
  3. Depreciation under s. 32 [other than s. 32(1)(iia)] shall be allowed.
  4. The loss referred to in clause b. above, shall be deemed to have been deemed to have been given full effect to and such loss shall not be allowed in any subsequent year.
  5. The above concessional rate under s. 115BAA shall be available at the option of the assesse company. Such option is to be exercised before the due date of filing of Return of Income. Such an option once exercised, cannot be withdrawn by the assesse in any subsequent year.

 

Effective Tax Rates under the existing provisions and s. 115BAA of the Income Tax Act 1961

As per the existing provisions of the Act, the tax rate for domestic companies having a turnover of INR 400 cr. in FY 2017 – 2018 is 25%. This shall further be increased by surcharge at the rate of 7% (when income is between INR 1cr. – INR 10cr.) or 12% (if income exceeds INR 10 cr.). Health and education cess at 4% shall be levied on tax payable and surcharge.

Under s. 115BAA, the assesse shall be liable to pay taxes at 22%. This shall be further increased by surcharge of 10% irrespective of the amount of income. Health and education cess at 4% shall be levied on tax payable and surcharge.

Thus, the effective tax rates under both options are as under :

Total Income Effective Tax Rate (including surcharge & cess)
If assesse opts for s. 115BAA If assesse does not opt for s. 115BAA
Upto INR 1 cr. 25.17% 26%
More than INR 1. Cr but upto INR 10. Cr 25.17% 27.82%
More than 10. Cr 25.17% 29.12%

 

In line with the background discussed above, let’s evaluate the existing tax structure as well as the tax structure if a company opts for s. 115BAA of the Act -

ILLUSTRATION I

Company A is a domestic company having a turnover of INR 350 crores in PY 2017 – 2018. During AY 2020 – 2021 , the company has purchased an asset of INR 50,00,000/- and is eligible to claim depreciation under s. 32(1)(iia) of the Act. It has a taxable income of INR 50,00,000/- after claiming depreciation under the normal provisions.

Calculation of tax liability under the existing provisions of the Income Tax Act 1961 as well as s. 115BAA

Particulars If the company does not opt for 115BAA If the company opts for 115BAA
Income after depreciation INR 50,00,000 INR 50,00,000
Less : Additional Depreciation

(INR 50,00,000 x 20%)

INR 10,00,000 -
Net Taxable Income INR 40,00,000 INR 50,00,000
Tax on the above at applicable rates – 25% / 22% INR 10,00,000 INR 11,00,000
Surcharge – 0 % / 10% - INR 1,10,000
Health & Education Cess @ 4% INR 40,000 INR 48,400
Total Tax Liability INR 10,40,000 INR 12,58,000

 

ILLUSTRATION II

Company A is a domestic company having a turnover of INR 350 crores in PY 2017 – 2018. During AY 2020 – 2021 , the company has purchased an asset of INR 50,00,000/- and is eligible to claim depreciation under s. 32(1)(iia) of the Income Tax Act 1961. It has a taxable income of INR 12,000,000/- after claiming depreciation under the normal provisions.

Particulars If the company does not opt for 115BAA If the company opts for 115BAA
Income after depreciation INR 1,20,00,000 INR 1,20,00,000
Less : Additional Depreciation

(INR 50,00,000 x 20%)

INR 10,00,000 -
Net Taxable Income INR 1,10,00,000 INR 1,20,00,000
Tax on the above at applicable rates – 25% / 22% INR 27,50,000 INR 26,40,000
Surcharge – 7% / 10% INR 192,000 INR 2,64,000
Health & Education Cess @ 4% INR 117,700 INR 1,05,600
Total Tax Liability INR 30,60,200 INR 30,09,600

Thus, under ILLUSTRATION I, the tax payable under the existing provisions of the  Act is lower even though the rate of tax is 25%. The company here gets the benefit of s. 32(1)(iia) of the Act and is also exempt for levy of surcharge since, the taxable income is lower than INR 1 crore. On the other hand, incase the company opts for s. 115BAA, it has to forgo it’s claim of additional depreciation under s. 32(1)(iia) and surcharge of 10% becomes applicable on the amount of tax payable.

Under ILLUSTRATION II, s. 115BAA is more beneficial to the assesse company even if it forgoes the benefit of additional depreciation under s. 32(1)(ii). However, it is also pertinent to note that the company has an increased meagre cash outflow only to the extent of INR 50,600/- incase it opts for the existing provisions of the Act.

In addition to the aforesaid, The CBDT in respect vide circular no 29/2019 dtd. 2nd October 2019 has issued clarifications incase the taxpayer opts for s. 115BAA of the Income Tax Act inserted through The Taxation Laws (Amendment) Ordinance, 2019.

  1. The Ordinance states that once, the taxpayer exercises the option to pay tax under s. 115BAA, it cannot be subsequently withdrawn and applies to all subsequent assessment years. The CBDT circular addresses the following concerns raised by taxpayers :
  • Allowability of brought forward loss on account of additional depreciation;
  • Allowability of brought forward MAT credit
  1. While exercising s. 115BAA, the domestic company cannot claim the benefit of additional depreciation under s. 32(1)(iia). Even the brought forward losses attributable to the same cannot be carried forward. Hence, a domestic company which exercises the option to pay taxes under s. 115BAA, cannot claim depreciation benefit under s. 32(1)(iia) for the year in which the option has been exercised and any other subsequent year. However, there is no time limit for the domestic company to opt for s. 115BAA. Accordingly, once all the brought forward losses attributable to additional depreciation have been set off, option to pay taxes under s. 115BAA can be exercised.
  2. Provisions of s.115JB are not applicable to companies paying taxes under s. 115BAA. Hence, it is clarified that tax credit of MAT paid by the domestic company exercising option under s. 115BAA is not available consequent to exercising such option. Further, since there is no timeline prescribed to opt for s. 115BAA, after the credit of MAT has been utilized, the domestic company can exercise s. 115BAA.

 

Conclusion

Before opting for s. 115BAA of the Act, the assesse company must evaluate the opportunities for foregoing deductions under various sections enunciated in the paragraph above.

Therefore, though prima facie the incentive in the form of a lowered tax rate under s. 115BAA seems quite lucrative, the pros and cons of opting for this section need to be understood since, when a company opts for s. 115BAA of the Act, it does not have the option to switch to any other provision and such an option would have to be exercised for the life time of the company