Menu
Tax Notes logo

Corporate Tax Cuts Could Spark Tax Credit Showdown in India

Posted on Oct. 14, 2019

Indian lawmakers are placing high hopes in the nation’s first “smart city”: the sprawling Gujarat International Finance Tec-City (GIFT City). GIFT City holds India’s first international stock exchange and is courting tech giants via lucrative tax breaks and promises of sophisticated infrastructure.

Google, Microsoft, Mastercard, and Visa are reportedly thinking about moving into GIFT City, which is also a special economic zone. It is advertising five-year and 10-year income tax exemptions and will eliminate a slate of other taxes (including sales, services tax, purchase taxes, customs duties, and excise duties) for companies depending on their stage of development. GIFT City is also an international financial services center, with Bank of America and Standard Chartered Bank having received approval to set up operations there.

GIFT City is the brainchild of Prime Minister Narendra Modi, who first drew up plans during his tenure as chief minister of the state of Gujarat. He hopes to replicate the controversial commercial and residential complex throughout India. According to local reports, the problem is that GIFT City is mostly empty despite the brand names considering the project.

As prime minister, Modi’s plans for other parts of India are similarly ambitious. He wants to double the nation’s economy to $5 trillion by 2025 despite the nation’s slowing economic performance. In the first quarter of the financial year, for example, India’s economy grew only 5 percent, marking a six-year low. In response, Modi turned to tax cuts. In late September, the government issued a series of surprise corporate tax cuts that generally drove down the corporate rate from 30 percent to 22 percent and delivered an attractive 15 percent rate to new manufacturing enterprises. The cuts are widely seen as an attempt to encroach on China’s position as a manufacturing powerhouse and undercut Singapore’s low corporate tax rates.

These rules are effective from the 2019-2020 tax year (starting April 1, 2019) and heavily favor new industries and fresh investments into India. Aside from the carveout for new manufacturing, companies that want to receive the 22 percent rate cannot claim any other corporate tax incentives or deductions. Unsurprisingly, business taxpayers want to avail themselves of the new corporate rate without losing precious tax credits they’ve accumulated over the years, especially credits from the country’s minimum alternate tax (MAT) regime. But the Central Board of Direct Taxes (CBDT) squashed those hopes in an October 2 explanatory circular. Still, the CBDT may not hold the last word on how MAT credits will be treated. Some companies could challenge it based on prior high court case law limiting the scope of CBDT circulars.

Corporate Tax Cuts

Under the new regime, companies that continue to receive exemptions and incentives will continue to be taxed at the 30 percent rate until the incentives end. At that time the tax rate will drop to 22 percent under new section 115BAA of the Income Tax Act, 1961 (Taxation Laws Amendment Ordinance 2019). Domestic manufacturing companies established after October 1 will enjoy a reduced 15 percent rate, provided they do not claim any exemptions or incentives and they start production on or before March 31, 2023.

The Indian government has made it clear that existing businesses that are split up or reconstructed will generally not qualify for the exemption, unless the reorganization occurred under a narrow set of parameters — for example because of a natural or man-made disturbance like a fire. Companies seeking the reduced manufacturing rate must also show that they will not use any machinery or plants previously used in India for any purpose, although used machinery imported specifically for a new venture is allowable.

New manufacturing companies and domestic corporations taxed at the 22 percent rate will be exempt from the minimum alternate tax on book profits. This rate has been reduced from 18.5 percent to 15 percent under updated ITA section 115JB. Once companies decide to either continue with their existing exemptions or switch to the reduced rate, they cannot change their decision. This follows the spirit of the tax changes, according to Neha Malhotra, executive director of Nangia & Co LLP.

“This was brought to encourage the growth of the Indian economy through new manufacturing companies and new domestic companies,” Malhotra told Tax Notes. “The current government wants new entrants because India’s manufacturing sector is bound to give a multifold growth from employment, from job creation, and from more business opportunities.”

MAT Credit Woes

India designed its MAT in light of otherwise profitable companies that were paying zero income tax after availing themselves of the country’s network of income tax incentives, including exemptions, depreciation, and deductions. Companies must pay whichever is higher between their normal tax liability and their MAT liability.

MAT applies broadly to all companies — domestic or foreign — subject to Indian income tax, with some limited exemptions for foreign entities that do not have a permanent establishment or do not have to register in India. Life insurance companies and shipping income already subject to tonnage tax are also exempt. Indian-based units of international financial centers are subject to a 9 percent MAT if they derive their income in convertible foreign exchange. But India decided to sweeten the regime in the form of credits: Companies subject to MAT in a given year can claim credits for any MAT that was paid above their normal tax liability within that period. Taxpayers can carry these credits forward for up to 15 years and apply them to years in which they are subject to their normal tax liability. The credits can only be used to reduce the regular tax liability down to the lower MAT level.

In September, the government was silent on how the new regime would affect taxpayers with existing MAT credits. Businesses sought clarification almost immediately after the announcement. Taxpayers also raised questions about how losses carried forward from additional depreciation would be treated going forward. Companies can take advantage of additional depreciation in cases where they have recently invested in machinery or infrastructure.

Some wanted to claim their existing MAT credits or losses from additional depreciation over their respective carryforward period while taking advantage of the reduced 22 percent rate. Others suggested the government should extend the MAT carryforward period. The MAT issue is important for companies already present in special economic zones that are availing themselves of tax holidays and racking up MAT credits to use in the future. It is also pertinent to companies that have generated substantial losses, pay the MAT, and have accumulated credits for when they do have future profits.

The CBDT answered some of those questions October 2 in a short circular that delivered bad news: Companies may not carry forward their losses from additional depreciation or MAT credits and simultaneously opt into the new 22 percent tax rate. If they wish to set off those losses or claim their credits, they will have to do so subject to the 30 percent tax rate. Because there is no deadline for participation, once their losses or credits have been exhausted, these companies can opt into the new, lower tax regime.

On the issue of depreciation, the CBDT reiterated its new statutory language under section 115BAA: Income computed under the new 22 percent tax regime must be computed without claiming the additional depreciation deduction, and without claiming any set-off losses carried forward because of additional depreciation. On the issue of MAT, the government clarified that since MAT is no longer available to companies opting into the reduced corporate rate, existing credits will no longer be available. Companies that wish to use up their credits will have to do so under the parameters of the old taxation regime within the 15-year carryforward period.

Challenging the Circular

Some commentators have suggested that the new circular could be challengeable based on several court decisions establishing that CBDT circulars are binding on the income tax department, but not on taxpayers. Section 119(1) of the ITA establishes the CBDT’s authority to issue instructions, directions, and orders to facilitate the proper administration of the act, and the Supreme Court of India has made it clear that such circulars must be interpreted in a taxpayer friendly manner, writing in one such challenge involving UCO Bank:

The Board thus has power . . . to tone down the rigour of the law and ensure a fair enforcement of its provisions, by issuing circulars in exercise of its statutory powers under Section 119 of the Income-tax Act which are binding on the authorities in the administration of the Act. Under Section 119(2)(a), however, the circulars as contemplated therein cannot be adverse to the assessee.” (UCO Bank, Calcutta v. Commissioner of Income-Tax, West (1999 [237] ITR 889)).

The Court based that position on a prior Court ruling in Keshavji Ravji and Co. v. Commissioner of Income-Tax, 1990 [183] ITR 1, in which the Court found that circulars issued under the CBDT’s statutory powers that tone down the law and are beneficial to the assessee are binding on Indian tax authorities.

A “circular cannot impose on the tax-payer a burden higher than what the Act itself, on a true interpretation, envisages,” the Court said.

The Court has also ruled that CBDT circulars may not amend legislative provisions (CIT v. Gopala Rao, 2017 [396] ITR 694). As such, some believe that the final word on MAT credits and depreciation should come from a statutory amendment and not from a circular.

The key question is whether the October 2 circular is a clarification to the ordinance (and therefore the CBDT’s interpretation stands), or whether is it a substantive change to the law (and therefore must be addressed via an amendment to the ordinance). Malhotra falls into the first camp.

“This is a clarification issued in respect of a specific section so this one is clarifying the intent of the law,” Malhotra said. “This kind of a circular is issued for the benefit of the taxpayer because then they will not take an adverse position that would drag them into litigation. So it is for their own benefit that they will not take a position that is bound to be challenged by the tax authority.”

On the issue of additional depreciation, the circular appears to be clear on why it is a clarification and not a substantive change to the law. It notes that the ordinance specifically disallows taxpayers who participate in the new regime from claiming a deduction under the additional depreciation rules (ITA section 32) and explicitly disallows those taxpayers from using any set-off losses from depreciation or other specifically mentioned tax incentives to calculate their tax liability.

The language of the new MAT provision under section 115JB is arguably less clear. The statutory language says the MAT will not be available to any taxpayer that opts into the 22 percent tax regime under section 115BAA, but section 115BAA does not explicitly include MAT credit carryforwards within its list of disqualifying tax incentives and deductions. Rather, the circular seems to say that since the incentives that would give rise to MAT credits are no longer allowed under the 22 percent regime, any accompanying credits are also disallowed for companies that opt into that regime.

Copy RID