Unit 4: Assessment of Companies - Subjective Questions

Company includes an Indian company, a body corporate incorporated under foreign law, an institution or association assessed as a company under earlier income-tax law, and an institution or association declared by the Central Board of Direct Taxes to be a company.

Domestic company:

• It is an Indian company or any other company that has made the prescribed arrangements for the declaration and payment of dividends within India.
• It may be eligible for concessional tax regimes if the statutory conditions are satisfied.

Foreign company:

• It is a company that is not a domestic company.
• Its Indian-source income and income attributable to a business connection or permanent establishment in India may be taxable in India.
• It is generally taxed at the rate prescribed specifically for foreign companies, subject to the applicable Finance Act and tax treaty.

Thus, the distinction depends mainly on incorporation, dividend-payment arrangements, residential status, and the tax rates applicable under the law.

The total income of a company is computed through the following steps:

1. Determine residential status: Establish whether the company is resident or non-resident to identify the scope of taxable income.
2. Classify income: Compute income under the relevant heads, namely house property, business or profession, capital gains, and other sources. Salary income is ordinarily not relevant to a company.
3. Apply special computation provisions: Consider depreciation, disallowances, transfer-pricing adjustments, deemed income provisions, and special tax rates.
4. Set off losses: Set off current-year losses and eligible brought-forward losses according to statutory restrictions.
5. Compute gross total income: Aggregate income under all applicable heads after permissible set-off.
6. Allow Chapter VI-A deductions: Deduct eligible amounts, subject to conditions and limits.
7. Arrive at total income:

The resulting total income is rounded off as prescribed and used for computing tax liability.

The normal tax liability of a domestic company is computed as follows:

• Calculate total income under the normal provisions of the Income-tax Act.
• Segregate income taxable at special rates, such as certain capital gains, lottery income, or other specified income.
• Apply the applicable corporate tax rate to ordinary income. The rate depends on the relevant assessment year, turnover conditions, and whether the company has opted for a concessional tax regime.
• Apply special rates to income covered by special provisions.
• Add the applicable surcharge.
• Add health and education cess at the rate prescribed by the relevant Finance Act.
• Reduce eligible rebates, reliefs, foreign tax credit, tax deducted at source, tax collected at source, and advance tax.

The broad formula is:

The normal tax liability must also be compared with liability under the Minimum Alternate Tax provisions wherever MAT applies.

Residential status determines the geographical scope of a company's taxable income.

Resident company:

• A company is resident in India if it is an Indian company or if its place of effective management is in India during the relevant previous year, subject to the statutory provisions.
• A resident company is generally taxable in India on its global income, including income earned or received outside India.

Non-resident company:

• A non-resident company is generally taxable in India on income received or deemed to be received in India and income accruing, arising, or deemed to accrue or arise in India.
• Business profits may be taxable when connected with a business connection or permanent establishment in India, subject to the applicable tax treaty.

Residential status therefore affects:

• The scope of total income.
• Availability of foreign tax credit.
• Application of tax treaties.
• Reporting of foreign income and assets.
• The final corporate tax liability.

Step 1: Set off the eligible current-year loss

Assuming the business loss is legally eligible for set-off against the stated business income:

Step 2: Compute gross total income

Step 3: Allow the eligible Chapter VI-A deduction

Assuming the deduction is allowable against the relevant component of gross total income and is not restricted by a special provision:

Step 4: Compute tax

• Apply the applicable corporate rate to ordinary income after appropriately allocating the deduction.
• Apply the prescribed special rate to the long-term capital gains.
• Add surcharge, if applicable.
• Add health and education cess.
• Compare the normal tax with MAT, where MAT applies.
• Reduce eligible prepaid taxes and tax credits.

The final numerical tax cannot be determined unless the assessment year, corporate tax regime, special capital-gains provision, surcharge slab, and applicable credits are specified.

Minimum Alternate Tax (MAT) is a tax mechanism under which certain companies must pay a minimum amount of tax based on their book profit when tax payable under the normal provisions is lower than the prescribed percentage of book profit.

MAT was introduced because some companies reported substantial accounting profits and distributed dividends but paid little or no income tax due to exemptions, deductions, allowances, and loss set-offs available under normal tax provisions. Such companies were commonly described as zero-tax companies.

The basic comparison is:

A company generally pays the higher of:

• Tax liability under the normal provisions; or
• MAT liability on book profit.

MAT therefore creates a minimum tax base linked to accounting profit while preserving the possibility of MAT credit according to statutory conditions.

Book profit for MAT is based on the profit shown in the statement of profit and loss prepared in accordance with the applicable company law, subject to specified adjustments.

The computation begins with net profit as per the statement of profit and loss. Prescribed items are then added back or deducted.

Common additions may include:

• Income tax paid or payable and related provisions.
• Amounts carried to reserves, except specified reserves.
• Provisions for unascertained liabilities.
• Provisions for losses of subsidiary companies.
• Dividends paid or proposed, where covered by the applicable provision.
• Expenditure related to specified exempt income.
• Certain depreciation and other amounts expressly listed by law.

Common deductions may include:

• Amounts withdrawn from eligible reserves or provisions, subject to conditions.
• Specified exempt income credited to the statement of profit and loss.
• Eligible depreciation adjustments.
• The lower of brought-forward book loss or unabsorbed book depreciation, where permitted.
• Other amounts specifically deductible under the MAT provision.

Thus:

Only adjustments expressly authorized by the MAT provision should ordinarily be made.

The company compares tax on normal total income with MAT on book profit and generally pays the higher amount.

MAT credit arises when the MAT paid by a company exceeds the tax payable under the normal provisions for a particular assessment year.

Creation:

• Credit is created only to the extent MAT exceeds normal tax.
• Payment of MAT does not permanently convert the excess into an immediate refund.

Carry-forward:

• The credit may be carried forward for the number of assessment years prescribed by the law applicable to the relevant year.
• It should be tracked year by year because expiry limits may apply.

Set-off:

• Set-off becomes available in a later year when normal tax exceeds MAT.
• The set-off is restricted to the difference between normal tax and MAT for that later year.

MAT credit does not generally carry interest merely because it remains unutilized, and its use is subject to statutory conditions.

Step 1: Compute MAT liability

Step 2: Compare MAT with normal tax

• Normal tax liability:
• MAT liability:

Since MAT is higher, the company is liable to pay tax under the MAT provisions.

Step 3: Compute MAT credit

Therefore:

• Governing basic tax liability:
• MAT credit generated:

Surcharge and health and education cess must subsequently be considered at the applicable rates. The actual statutory rate and possible concessional or special-regime exclusions must be verified for the relevant assessment year.

Dividend Distribution Tax (DDT) was a tax imposed on specified dividends distributed, declared, or paid by a domestic company. Under the earlier system, the company paid additional income tax on distributed profits, while the dividend was generally exempt in the hands of shareholders, subject to exceptions and additional provisions.

Important features of the former system:

• Liability arose at the company level.
• DDT was in addition to the company's regular income tax.
• It applied to specified distributions treated as dividends.
• Grossing-up rules could increase the effective tax burden.
• Payment was required within the prescribed period.

Legal evolution:

• The DDT regime was abolished for dividends distributed on or after the date specified by the Finance Act, 2020.
• Under the current classical system, dividends are generally taxable in the hands of shareholders at the rates applicable to them.
• The company may be required to deduct tax at source from dividend payments.

Therefore, DDT remains important for historical assessments and conceptual study, while current transactions are ordinarily governed by shareholder-level taxation.

The present system aligns dividend taxation more directly with the income and status of the recipient.

For tax purposes, dividend is wider than an ordinary dividend declared by a company. In addition to normal distributions to shareholders, the statutory definition may include specified deemed distributions.

Examples may include:

• Distribution involving the release of company assets to shareholders.
• Distribution of debentures, deposit certificates, or bonus shares to preference shareholders in specified circumstances.
• Distribution to shareholders on liquidation, to the extent attributable to accumulated profits.
• Distribution on reduction of share capital, to the extent covered by accumulated profits.
• Certain loans or advances by a closely held company to a significant shareholder or a specified concern, subject to detailed conditions and exceptions.

These amounts are treated as dividends because they may represent an indirect distribution of accumulated profits. The deemed-dividend rules prevent companies and shareholders from avoiding dividend taxation merely by changing the legal form of the payment.

The exact tax treatment depends on the relevant statutory clause, recipient, exceptions, and assessment year.

Under a grossing-up system, the distributed amount is treated as the net amount remaining after the distribution tax. The grossed-up base is calculated as:

Given:

Therefore:

The basic DDT would be:

Thus, the company would bear a basic distribution tax of , before applicable surcharge and cess. This is a historical illustration; DDT has been abolished under the current dividend-taxation system.

A domestic company distributing dividends should consider the following compliance requirements:

• Identify the recipient: Determine whether the shareholder is resident or non-resident and whether any special status applies.
• Determine TDS applicability: Deduct tax at source when the statutory threshold and other conditions are satisfied.
• Apply the correct rate: Consider the Income-tax Act, the relevant Finance Act, and, for a non-resident, an applicable tax treaty.
• Verify documents: Obtain prescribed declarations, tax identification details, residency certificates, and treaty-benefit documents where necessary.
• Deposit tax: Pay the tax deducted within the prescribed time.
• File statements: Report the deduction in the relevant TDS return.
• Issue certificates: Provide the prescribed TDS certificate to the shareholder.
• Maintain records: Preserve board resolutions, dividend registers, payment details, declarations, and tax-working papers.

Failure to comply may result in interest, penalties, disallowance, and treatment as an assessee in default, subject to statutory reliefs.

Under the former distribution-tax regime, specified income distributed by a mutual fund or another covered entity to its unit holders could attract an additional income tax at the level of the distributing entity.

Its main features were:

• The tax was imposed on specified distributed income rather than on the fund's ordinary taxable profits.
• Different rates could apply depending on the nature of the scheme and the category of unit holder.
• Grossing-up provisions could apply in determining the taxable distribution base.
• The distributing entity was responsible for payment and related compliance.
• The corresponding income was generally exempt in the hands of unit holders, subject to the law then in force.

The Finance Act, 2020 replaced this approach for relevant distributions with taxation in the hands of unit holders. Consequently, income distributed by mutual funds is now generally taxable for recipients, and the payer may have a tax-deduction obligation.

Although both were entity-level distribution taxes, they applied to different legal relationships, instruments, recipients, and statutory provisions.

Under the present broad framework, income distributed by a mutual fund is generally taxable in the hands of the unit holder.

Resident unit holder:

• Distribution income is generally included in total income under the applicable head.
• Tax is charged at the rate applicable to the recipient, subject to any special provision.
• The mutual fund may deduct tax at source when the payment exceeds the prescribed threshold and the statutory conditions are met.

Non-resident unit holder:

• Indian tax may be deducted at the rate prescribed by domestic law.
• A lower treaty rate may be claimed if the distribution is covered by the treaty and the unit holder satisfies eligibility, beneficial-ownership, residency, and documentation requirements.
• Foreign tax credit may be available in the country of residence according to its domestic law and the treaty.

The tax treatment of income distribution must be distinguished from gains arising on the redemption or transfer of units, which are generally examined under capital-gains provisions.

Income distribution on units:

• Arises when a mutual fund distributes income to unit holders.
• Is generally taxable as income in the recipient's hands under the applicable provisions.
• May be subject to tax deduction at source.
• Does not ordinarily depend on the unit holder transferring the units.

Capital gain on redemption:

• Arises when units are redeemed, sold, or otherwise transferred.
• Is calculated by comparing the consideration with the tax cost, subject to applicable adjustment rules.

• Its classification and rate depend on the nature of the fund, the period of holding, the date of acquisition or transfer, and the law applicable for that year.
• Capital losses may be set off or carried forward only according to the prescribed rules.

The two receipts should not be confused: one is a return distributed while holding units, whereas the other results from disposal or redemption of the investment.

A systematic framework is as follows:

1. Compute normal total income

2. Compute normal income tax

• Apply the ordinary corporate rate to ordinary income.
• Apply special rates to specified income.
• Add applicable surcharge and cess.

3. Compute book profit for MAT

4. Compute MAT liability

Add applicable surcharge and cess.

5. Select the higher liability

6. Consider MAT credit

• When normal tax exceeds MAT, allow eligible brought-forward MAT credit up to the statutory limit.
• When MAT exceeds normal tax, record eligible new MAT credit.

7. Deduct other credits and prepaid taxes

• Foreign tax credit.
• Tax deducted at source.
• Tax collected at source.
• Advance tax.
• Self-assessment tax already paid.

8. Determine the balance

• Add applicable interest and fee.
• Round off according to statutory rules.
• The result will be tax payable or refund due.

The assessment year and the company's chosen tax regime must be verified because rates, exemptions, and MAT applicability may differ.