Budget 2022: A few bold steps needed on Tax amendments towards 'Ease of doing Business'

Union Budget 2022-2023 is round the corner, and as always, there are expectations and a wish list.  We are also in the middle of one of the most difficult periods in the last several decades, and although, there is some silver lining in terms of likely tapering, it has caused significant havoc in terms of illness and deaths, and indeed to several parts of the economy.

In the above context, the need for facilitating Ease of Doing Business (‘EODB”) becomes even more important and one is fervently hoping that the Union Budget addresses some of these issues.

 Business reorganization is important at any point of time, but in the current context, the need is even more strongly felt.  One aspect is splitting up unrelated businesses, the other is consolidation into a large business whether within a group or outside. In this context, here are a few provisions that urgently need attention:

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A classic example of an outlier provision is the one which puts the onus on a company to establish that “excessive” share premium is not income. Existence of some outlier cases of transactions of this nature should not be the reason to introduce such provisions; clearly, it amounts to throwing the baby out with the bath water and is causing tremendous confusion, and indeed, litigation.

A deemed gift kind of provision has been introduced some years back in the form of Section 56(2)(x); the sweep of this section has widened considerably over the years. As an example, what the tax department considers a non tax neutral demerger can fall within this section; given that this controversy can arise several years later, one shudders to think of the litigation and consequences on the company which is the recipient of the demerged division.

In relation to unlisted companies, there is a provision vide Section 50CA that the floor price for a share transaction should be the adjusted net book value (ANBV) (adjustments for reckoner value of immovable property, and market value of investments in listed shares). Large deals could go into loops due to this – take the case of a stressed unlisted company with a manufacturing unit housed in a valuable immovable property. The property cannot be sold, because it is not possible to shift the factory except at substantial cost. However, in selling the shares of the company, if the transaction is done below the ABNV (commercially agreed with the buyer), the transferor will be liable to deemed capital gains tax and transferee will be liable to deemed gift tax under the above referred Section 56(2)(x)!

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While India still needs to issue policies regarding cryptocurrencies, a lot of clarity shall be required around taxation of cryptocurrencies as well. Issues such as characterization of income from sale of cryptocurrencies (business income, capital gains or other income), cost of acquisition for cryptocurrency miners, taxation of Initial Coin Offerings, and ambiguity on related matters will require clarifications to avoid uncertainties.

A major pain point for many years has been taxation of ESOPs; the stages of ESOPs are grant, vesting and exercise, and sale can happen at any point after exercise. However, taxation is at the point of time of exercise; at this stage, there is no monetization and logically, the point of time should be the point of sale.  Of course, one could break up the gain between the salary taxable at higher rate (fair value minus exercise price) and capital gain (selling price minus fair value on exercise), but the point of time of taxation should be the point of sale.

For companies, the tax rates are very reasonable now at 25%, but the difference between tax rate of a partnership / LLP at 36% and company at 25% seems unjustified. While there is no tax on distribution by LLP (unlike in case of dividend payouts), substantial profits of a company, in most cases, are locked up in working capital or expansion and typically only 30% - 40% of PAT is distributed as dividend, sometimes not even that. If one considers an average dividend tax burden of 20% on 30% - 35% of PAT, it would be 5% - 7%; accordingly, at the most, the partnership/LLP rate should be 30%. Incidentally, most partnerships / LLPs are in the MSME category, and MSMEs account for 30% of India’s GDP and 100 mn jobs! This sector badly needs a real EODB push!

The tax rate for individual incomes above Rs 50 lacs is almost 35%.  One would think that this limit of Rs 50 lacs should be at least Rs 1 cr and total rates should be not more than 30%, since punitive rates of 35%-43% are a direct incentive for evasion.

Tax laws are inherently complex, but within that complexity, one would wish that the above issues can be addressed since they would go a long way in making life less difficult for the taxpayer, particularly MSMEs which have been badly hit by the pandemic and could get some relief if tax rates are more reasonable and complexity is reduced.