Employee share based payments: Understanding the taxation aspects

By Rahul Maharshi (rahul@vinodkothari.com), (finserv@vinodkothari.com)

Introduction

Employee share based payments (ESBPs) are an effective way of incentivising employees. ESBPs work as a two way growth strategy for both company as well as the employees. On one hand, it helps the employees to participate in the growth of the entity and in turn reap out the benefits from it, on the other hand it helps the entity to boost the growth rate and align the vision of the employees with that of the company. The ESBPs work as a catalyst for the employee growth as well as the growth of the company.

The theme of this article revolves around the taxation aspects of different types of ESBPs, but before we proceed further, let us have a quick understanding about the different types of ESBPs.

Types of ESBPs

There are various types of ESBPs which an entity can offer to the employees. However, the choice of offering a specific type of ESBP depends upon various factors, such as growth strategy of the entity, degree of dependence on the performance of the entity, regulatory restrictions and tax implications.

Some of them are Employee stock option plans (ESOPs), Employee Stock Purchase Plans (ESPPs), Stock Appreciation Rights (SARs), sweat equity shares, Phantom Stock Plans explained below:

Employee Stock Option Plans (ESOPs): ESOPs are in form of contracts which gives employees a right, but not an obligation, to purchase or subscribe to a specified number of shares of the company at a fixed price, that is, the exercise price. The exercise price remains fixed even if the market price goes up in future.

One may compare an ESOP to a future contract, particularly to a call option, which entitles the holder of the option a right to buy securities on a future date at a predetermined price viz. the current market price on the date of granting the option.

However, there exist a primary difference between two, being the tradability of such option in the market. A future contract in the nature of a call option is traded in the stock market, but an ESOP is not traded in the market. Also, an ESOP is specifically offered to an employee and there exist a performance factor which helps in enhancing the wealth of the company, in turn making the option in the money.

Employee Stock Purchase Plans (ESPPs): ESPP is a plan under which the company offers shares to its employees at a discounted price as part of public issue or otherwise.  In comparison to an ESOP, ESPP provides immediate reward to the employee in the form of shares at discounted price.

Stock Appreciation Rights (SARs): SARs are rights that entitle the employees to receive cash or shares for an amount equivalent to the excess of market price on exercise date over a stated price. The SAR which is settled by way of shares of the company are referred to as equity settled SARs. The SAR which is settled by way of cash are known as cash settled SARs.

Sweat Equity Shares: Sweat equity shares are such equity shares which are issued by the company to its directors or employees at a discount or for consideration, other than cash for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.

For a company, the determining factors to choose one of the above schemes may depend upon the preference of the company. For example, a company would go for an ESPP, if immediate increase in shareholding is required in place of an ESOP, where the shareholding changes after exercise. On the other hand if the company does not want any change in shareholding, it would go for an SAR.

External factors, such as regulatory restrictions and tax implications also affect the choice. In India, the choice primarily depends upon regulatory restrictions and tax implications.

Tax implication on ESOPs

Employee Perspective

ESOPs are a kind of fringe benefit over and above the employee’s salary. Post amendment to the Finance Act, 2009, ESOPs have been made taxable in the hands of the employees as Perquisite. Earlier they were taxable in the ambit of Fringe benefit tax.

To understand the tax implication on ESOPs, we first need to understand the process flow in case of an ESOP issuance.

The steps involved in an ESOP begins with granting of options to the eligible employees whereby the employees get a right to acquire shares of the company in future at a predetermined price. The right to acquire the shares are provided under a scheme and the option may be exercised after a certain number of years, known as vesting period. After the vesting period, the employees with the options are eligible to exercise them at the predetermined price, known as the exercise price (EP).

The incidence of income tax on the employees, in case of ESOP are at two events:

  1. At the time of exercise of the options (Allotment of shares to employees)
  2. At the time of sale of shares by the employees
At the time of exercise of the options (Allotment of shares):

As explained earlier, ESOPs were under the ambit of fringe benefit tax till the amendments vide Finance Act, 2009. Post the amendments, ESOPs have been made taxable in the hands of the employees as perquisites under section 17 of income tax act, 1961 (IT Act).

As per clause (vi) of sub-section 2 of section 17 of the IT Act:

(2) “perquisite” includes—

…………………..

(vi) the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee.

                ……………………

Explanation.—For the purposes of this sub-clause,—

  • “specified security” means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees’ stock option has been granted under any plan or scheme therefor, includes the securities offered under such plan or scheme;

Therefore, at the time of exercise of the options by the employees, the difference in fair market value (FMV) of the shares allotted and the exercise price is treated as perquisite.

The guidance for determination of the FMV of the share(s) allotted is been given in the Income tax Rules, 1962 (IT Rules). As per sub-rule (8) of Rule 3 of the IT Rules, if the shares allotted are of a listed company, the FMV shall be the average of the opening price and closing price of the share on that date. In case of unlisted shares, the FMV shall be such value of shares in the company as determined by a Merchant Banker on the specified date.

The method of deduction of the said perquisite will be similar to deduction of tax from salary, in which the employer shall deduct TDS on the said perquisite value in addition to the TDS on salary u/s 192 of the IT Act.

At the time of sale of shares by the employees

Logically, an employee shall exercise the option when the same is in the money. Upon exercise of the option, the employee can either hold the share or it can sell off shares immediately and realise the gains. Realisation of gains will attract capital gains taxation.

The capital gain tax would be calculated as a difference between the sale consideration and the fair market value as on the date of exercise of the options.  As per section 2(42A) of IT Act, the period of holding such shares should be considered from the date of allotment of such shares.

The period of holding the shares shall determine whether they attract a tax on long term capital gains (LTCG) or short term capital gains (STCG).

At the time of sale of shares by the employee, companies whose shares are listed on any recognised stock exchange shall attract capital gains tax as follows:

  1. Shares held for a period less than or equal to 12 months to be considered Short term. As per section 111A of the IT Act, the tax on listed shares held as short term are to be taxed at a flat concessional rate of 15%.
  2. Shares held for a period of more than 12 months are to be considered long term. Prior to Finance Act, 2018, LTCG tax on listed shares were exempted vide section 10(38) of IT Act, provided the transaction of sale was chargeable to securities transaction tax (STT). The exemption was withdrawn vide Finance Act, 2018, correspondingly section 112A was introduced in the IT Act to impose an LTCG tax at a concessional rate of 10% on the gains in excess of Rs. 1 lakhs on transfers made on or after 1st April, 2018.

At the time of sale of shares by the employee, companies whose shares are not listed on any recognised stock exchange shall attract capital gains tax as follows:

  1. Shares held for a period of less than or equal to 24 months are to be considered short term. Tax on the same is treated similar to any other income and taxable as per applicable income tax slab rate on the employee.
  2. Shares held for a period of more than 24 months are to be considered long term. As per section 112 of the IT Act, LTCG tax on the same is to be charged at the rate of 20% with the benefits of indexation.

The treatment of ESOP in the hands of employee is diagrammatically represented below:

Employer Perspective

ESBPs are a way of incentivising the employees, there are income tax implications in the hands of employees, however, in case of the employer, there is an implication of whether the expense on ESOP be allowable or not. As the discount provided through the ESOP is a general expense, it is to be considered as a general provision under Section 37 of the IT Act.

The allowability of the expense has always been litigious and questionable. There have been decided judgments wherein the expense incurred by employer is treated allowable. Held in the case of CIT vs. Lemon tree Hotels Ltd., August, 2015[1], the disallowance of ESOP expenses of Rs. 1,28,19,169/- by the Assessing Officer (AO) was rejected  by the Delhi High Court and was allowed as an expense.  Also, held in case of CIT (A) vs. People Interactive India Pvt. Ltd., October, 2015[2] that the discount allowed under ESOP shall be treated as employee cost deductible over the vesting period.

Section 37(1) of the IT Act, which grants deduction for the expenses which are not particularly mentioned in Sections 30 and 36 are neither personal expenses nor capital expenditures of the assessee.

Tax Implications on ESPPs

Unlike ESOPs, ESPPs are a medium of providing incentive to the employees by offering shares at discounted price immediately. ESPP is a plan under which the company offers shares to its employees at a discounted price as part of public issue or otherwise.

ESPPs allow the employees to use their salary to purchase the shares of the company offered at a discounted price.  Generally, the consideration to be provided for ESPP are paid by the employees by way of monthly deduction from their salary.

Generally, there is a specific lock-in period of one year from the date of allotment, if the shares offered under ESPP have been issued at a discount.

Employee Perspective

In case of ESPPs, the incidence of tax, in hands of the employee, arises on the fact that the securities are issued at a discount, and hence, the difference between the discounted price, and the market price on the purchase date is to be considered as income.

The above income is taxed in the hands of the employee as “perquisites” under clause (vi) of sub-section (2) of section 17 of the IT Act.

Similar to the tax implication in case of ESOPs at the time of exercise of the option and allotment of the shares, the same requirement applies in case of ESPPs.

The only difference is, that in case of ESOPs the perquisite value is the difference in FMV and exercise price, in case ESPPs the perquisite value is the difference between FMV and the discounted price at which the shares are sold to the employees.

The guidance for determination of the FMV of the share allotted, given in the Income tax rules, 1962 (IT rules) as explained above, in case of ESOPs shall apply similarly to arrive at the FMV of the shares on the date of sale to the employees.

The treatment of ESPP in the hands of employee is diagrammatically represented below:

In case of ESPP, the employees allow the employer to withhold a certain portion of his monthly salary, the accumulated amount of which is utilized to acquire shares at a discounted value.

At the time of sale by the employee, the tax implications similar to that applying in case of ESOPs shall apply.

Employer Perspective

ESPPs generally allow the employees to purchase shares of the company through after-tax payroll deductions. ESPPs are provided to employees at a discounted price as part of public issue or otherwise and there is an immediate offer of shares. Hence, there does not arise a requirement of vesting, like in case of ESOPs.

ESPPs are generally  Unlike ESOPs, there does not arise a case of allowability of expenses are a way of incentivising the employees, there are income tax implications in the hands of employees, however, in case of the employer, there is an implication of whether the expense on ESOP be allowable or not. As the discount provided through the ESOP is a general expense, it is to be considered as a general provision under Section 37 of the IT Act.

Section 37(1) of the IT Act, which grants deduction for the expenses which are not particularly mentioned in Sections 30 and 36 are neither personal expenses nor capital expenditures of the assessee.

Tax Implications on SARs

As already discussed, SAR is a form of ESBP whereby the employees become entitled to a future cash payments or shares which is based on the increase in price of the shares from a specified level or a specified period. SARs are rights that entitle the employees to receive cash or shares for an amount equivalent to the excess of market price on exercise date over a stated price. Typically, SARs can be of two kinds: (a) Equity settled SARs; (b) Cash settled SARs.

Equity-settled SARs

In case of Equity settled SARs, the settlement amount, i.e. the amount based on the increase in price of the shares on the grant date, compared with the price on the exercise date, is provided in the form of shares of the company.

The equity-settled SARs are more or less similar to ESOPs since the settlement is in shares of the company. However, the major difference between the two is that in case of ESOP, at the time of exercise, the employee is required to pay the discounted price i.e. the exercise price to the company. But in case of SARs, the employee is not required to pay any amount, rather the employee receives shares of the amount of appreciation.

The tax implication of equity settled SAR is explained below:

Employee perspective

The incidence of income tax on the employees, in case of Equity settled SARs are at two events:

  1. At the time of exercise of the SARs (Allotment of shares of the appreciation value to employees)
  2. At the time of sale of shares by the employees
At the time of exercise of the SARs

On exercising the right, employee receives shares of the company of the amount of appreciation which the shares of the company has achieved.

For example, Mr. X, an employee of ABC Ltd. has been granted 1,000 SARs with a price of Rs. 10 per share, to be exercised at the end of 3 years from the date of grant. The price of the shares of ABC Ltd, at the end of 3 years appreciates to Rs. 100. Since the SARs are equity settled, Mr. X is eligible to get the appreciation in terms of shares of ABC Ltd. The appreciation being the difference in share price multiplied by no. of SARs granted and exercised [i.e. (100-10)*1000= Rs. 90,000].Therefore, Mr. X is eligible to get 900 shares of Rs. 100 each of ABC Ltd amounting to Rs. 90,000.

As per section 17(2)(vi) of the IT Act, at the time of exercise of the SARs by the employees, the difference in fair market value (FMV) of the shares allotted and the exercise price is to be treated as perquisite.

Since the appreciated value is given in shares to the employee, without any consideration taken from the employee, the said appreciation in the value of shares will become the value of perquisite.

Now, for the purpose of determining the perquisite value, the FMV of the shares are to be arrived at as per the guidance provided in the Income tax rules, 1962 (IT rules). As per Sub-rule (8) of Rule 3 of the IT rules, if the shares allotted are of a listed company, the FMV shall be the average of the opening price and closing price of the share on that date. In case of unlisted shares, the FMV shall be such value of shares in the company as determined by a merchant banker on the specified date.

At the time of sale of shares by the employees

When the employee sells such shares at a future date, the capital gain arising from such sale shall be taxable on the date of sale of such shares.

Capital gain, here, shall mean excess of ‘sales consideration of shares’ over the ‘cost of acquisition of shares. Sale consideration shall mean the amount actually received against sale of such shares. Cost of Acquisition shall mean the value of such shares as on date of exercise of SARs which was considered for perquisite tax determination i.e. the FMV arrived at the time of exercising the SARs.

The tax treatment of SARs in the hands of employee is diagrammatically represented below:

 

Cash-settled SARs

In case of Cash settled SARs, the employee is paid the difference in value of shares between the date of exercise of right and the date of grant of right. There is no actual transfer of shares in this case.

The tax implication of equity settled SAR is explained below:

Employee perspective

Since, in case of cash settled SAR, the amount of appreciation in value of shares is paid to the employee in cash, the said amount is directly treated as perquisites. The amount of appreciation in value of shares received by way of cash payment from the Company is subject to tax in the hands of the employee as perquisite. It is treated as part of salary and is accordingly taxed.

The treatment of ESPP in the hands of employee is diagrammatically represented below:

Employer perspective

The amount of appreciation paid by the Company to the employee in cash is allowed to be claimed as expenditure under Section 37 of Income Tax Act.

Also, as per section 192, the company is under the obligation to deduct tax at source, on such payment of compensation.

Conclusion

ESBPs are a way of incentivising the employees, there are income tax implications in the hands of employees, and still the medium of incentivising is lucrative and in turn beneficial for the growth of the company as a whole.

However, with recent changes brought in through Finance Act, 2018 and particularly through withdrawal of exemption under section 10 (38) the tax implication in hands of the employee has increased.

There has been a proposal by the Department for Promotion of Industry and Internal Trade (DPIIT) to the finance ministry for reviewing the taxation of employee stock ownership plans for addressing issues that curb their effectiveness as a compensation tool. Such review is not be confined to start-ups and would be holistic. The same may result in a substantial change in the way ESBPs are taxable.

Currently, In case of the employer, Ind AS implementation and applicability of Ind AS 102- Share Based Payments the requirement of fair valuation of the employee compensation expense has resulted in higher expense recognition in the initial years and trending to taper off in the later years. The same is to be seen whether the expense recognition will come in alignment with the allowance by the tax authorities.



[1]
http://itatonline.org/archives/wp-content/uploads/Lemon-Tree-ESOP.pdfThe treatment of ESPP in the hands of employee is diagrammatically represented below:

[2] https://indiankanoon.org/doc/154254860/

 

 

Whether burden shared by captives comes under GST?

Extended clarification required

-Yutika Lohia

yutika@vinodkothari.com

Introduction

Interest subvention income are earnings received from the third party i.e. person other than the borrower. This scheme work as a compensation to the seller who intends to penetrate the market. They arrange low cost finance for their customers (though not low cost because the part of it is compensated by its captive unit).Therefore the seller (lender) offers subsidized rate to the buyer (borrower) and the discounts are borne by the third party who is either a captive unit of the seller or also by Central or State Government who plans to provide financial aid through subvention.

In the case of Daimler Financial Services India Private Limited[1] (DFSI), the advance authority passed a ruling where it was concluded that interest subvention is like “other miscellaneous services” which was received from Mercedes-Benz India Private Limited (MB India) by DFSI and will be chargeable to GST as a supply.

The case of Daimler Financial Services India Private Limited

In the said case, DFSI is registered as an NBFC and is engaged in the business of leasing and financing. DFSI is a captive finance unit of MB India where the customers get a rebate in the interest component when DFSI acts as a financer and the car is purchased from one of the authorized dealers of MB India. MB India is engaged in the manufacture and sale of car which is usually done through its authorized dealer. The difference interest amount for each transaction is paid upfront by MB India to DFSI who raises an invoice against MB India. Payments made by MB India for the interest subvention was done after deducting TDS under section 194A of the IT Act.

The assessee contended that the interest subvention received is an interest and is an exempt supply. Also, the GST law and the Indian Contract Act 1872 recognize that consideration for a transaction can flow from anybody. The loan agreement with the customers also mentioned the applicable interest rate, the interest subsidy received from the MB India and the net interest payable by the customer.

Several reference of rulings were submitted by the assessee through which it contended that

  • The interest subvention is a subsidy which is made to offset a part of the loss incurred by charging a lower rate of interest.
  • Consideration can flow from a person other than the borrower.
  • If a contract stipulates that for the use of creditor’s money a certain profit shall be payable to the creditor, that profit is interest by whatever name called.

The following points were put up by the department:

The department that DFSI had not borrowed money from MB India. Also interest income can be exempt when there is a direct supply. It was also put that the interest income exempt through notification is not valid for a payment made by third party. The whole structure was set up to promote the business of DFSI.

The department gave reference to section 15 of the CGST Act, where value of supply includes subsidies directly linked to price and the amount of subsidy will be included in the value of supply. Therefore “interest subvention” is an interest subsidy and hence chargeable to GST. Also it was noted that income booked by DFSI is shown under revenue from operations as subsidy income.

The ruling concluded that interest received by DFSI from MB India was to reduce the effective interest rate to the final customer is chargeable to GST as supply under SAC 999792 as other miscellaneous services, agreeing to do an act.

The law behind interest subvention

As per the exempted list of services[2], consideration represented by way of interest or discount on services by way of extending loans or advance is an exempt supply. As it is evident, that services exclude any transaction in money but includes activities relating to use of money i.e. processing fees falls within the meaning of activities relating to use of money and therefore charged to GST.

When there is an interest subsidy, there are two arrays of interest involved- “applicable fixed interest rate gross” and “Net applicable fixed interest rate”. The borrower is under no obligation to pay the lender interest on principal i.e. the applicable fixed interest rate gross. The lender pays at the net applicable fixed interest rate. The difference between the two arrays of interest is the interest subvention borne by the third party. Technically the consideration paid by the borrower is the subsidized rate of interest. The borrower indirectly pays the differential amount of interest through the third party. Therefore referring section 7 of the CGST Act, consideration paid by the borrower is in the course of business whereas consideration paid by the third party is for furtherance of business. The two considerations received are totally different as one is “interest” and the other is “interest subsidy”.

Further, referring to section 15 (2) (e) of the CGST Act, value of supply of includes subsidies directly linked to the price excluding subsidies provided by the Central and State Governments. The interest subvention received are directly linked to price i.e. the interest paid by the borrower to lender and should be considered as value of supply.

Also the definition of “interest” is defined by the council as – “interest” means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised;

The interest paid on money borrowed is under the exempted category of services. Interest subvention disbursed by the captive unit of the lender is not paid on any money borrowed. It is a form of consideration paid so as to promote the business indirectly. They are like any other charges and therefore should not be considered as interest on money borrowed.

Since interest subvention is not interest on money, the same is not an exempt supply and therefore under the purview of GST.

Conclusion

The Advance Ruling Authority (AAR) interpreted the law and considered interest subvention to be taxable under GST. Further clarification is still required on its taxability as  one may note that as per section 103 of the CGST Act, the rulings pronounced by the  Authority is only binding on the applicant.

Therefore, whether interest subvention is taxable under GST or not requires further attention from the department.

 

[1] http://www.gstcouncil.gov.in/sites/default/files/ruling-new/TN-16-AAR-2019-Daimler%20FSIPL.pdf

[2] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification9-IGST.pdf;jsessionid=B71F3824BBE3E6EF8C805B56978C9C9F

Applicability of GST on penal charges

By Yutika Lohia (yutika@vinodkothari.com)

Introduction

The Goods & Services Tax (GST) has been the biggest tax reform in India founded on the notion of ‘one nation, one market, one tax’. It has and will further affect the entire economy including core industries such as agriculture, manufacturing, finance, service, infrastructure etc. The tax reform has been touted to create a significant positive impact on the economy in the long run. Unfortunately however, GST has not been exception to the fact that any big transition faces short term pains. The GST council has been receiving numerous queries and doubts from the myriad industries and trading associations regarding its applicability and nuances on the supply of various goods and services. One such concern had been on the issue of its applicability on additional/penal interest.

Recently the Council came up with a circular on “Clarification regarding applicability of GST on additional / penal interest” on 28th June, 2019[1] to address the issue.

The word “penal”

Black’s law dictionary defines penalty as ‘punishment imposed by statute as a consequence of the commission of a certain specified offense.” Subsequently as such the word “penal” is something relating to or containing a penalty. To put it in perspective, any default in payment of a loan transaction or in the supply of goods or services is liable for a penalty, which may be fixed or variable and thus may be in the name of additional interest or penalty interest, or overdue interest.

In a financial transaction, when there is a delay in the payment of EMI by the customer/borrower, the lender collects penal /default interest as additional interest for the period of delay, determined in days, months or years as per the agreed terms between the two.

Chargeability of GST

Penal charge is levied when there is delayed payment in a money-to-money transaction or when there is a supply of goods or services.

First let us understand whether the penal interest will be included in the value of supply.

As per section 15(2)(d) of the CGST Act, value of supply includes “interest or late fee or penalty for delayed payment of any consideration for any supply.”

Therefore, any interest or penalty paid for delayed payment in the supply of goods or service or a loan transaction shall be included in the value of supply i.e. the consideration amount.

Further, penal charges will not be covered under Schedule II- Activities to be treated as a supply of goods or services in clause 5(e), where supply of services include “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”

The expression “to tolerate an act” used in the above clause, should be understood to cover instances where the consideration is being charged by one person in order to allow another person to undertake any particular activity. Therefore it is very clear that at the very inception of the transaction, the intention of one party is to undertake an activity and the other party shall allow the same without any deterrent. To say, the contract is entered to allow the other person to carry out an activity, and not as a penalty or limit the person for carrying out such act in future.

Furthermore, the word “obligation” used in the clause 5(e) of Schedule II where the service recipient requests the service provider to tolerate an act/situation and the service provider obliges to tolerate for a consideration, then such a contractual relationship shall be covered in the above mentioned clause. Therefore it can be said that there is a consensus ad idem between the contracting parties.

Contrary to the above, penal interest/charges are collected only when an event occurs i.e. when there is a default in a payment of a loan transaction or supply of goods/services. The intention of the parties entering into a contract is either to avail the services in way of loan or supply of goods. Penal charges are to be paid if there is a breach in the contract and therefore it does not mean that the parties have entered into a contract for the penal interest.

Therefore penal charges does not fall under the deemed supply list given in Schedule II of the CGST Act.

As penal interest satisfies the definition of “interest” given in the notification, penal interest charged by parties who enter into a contract of giving loans will be covered under serial no. 27 of the notification dated 28th June, 2017.

Ergo, penal charges levied by the lender in a money to money transaction will have no GST implications.

Services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount is an exempt service and penal charges levied by the vendor on delayed payment in case of supply of goods and services shall be under the purview of GST.

Various clarifications by the GST Council on additional/ penal interest taxability

The GST department’s explanations regarding the applicability of GST of additional / penal interest are listed below:

1.      FAQs on financial sector

The Central Board of Indirect Taxes and Customs (CBIC) came up with a frequently asked questions document (FAQs documents) on financial sector[2] where taxability of additional interest in GST was discussed in serial no 45 of the document.

Any additional interest charged on default in payment of instalment in respect of any supply which is subject to GST, will be included in the value of supply and therefore will be liable to GST.

2.      Notification No. 12/2017-Central Tax (Rate) dated 28th June 2017[3]

The department exempts services by way of extending deposits, loans or advances in so far that the consideration is represented by way of interest or discount (other than interest involved in credit card services).

Also the notification defines the word “interest” which means “interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised.”

Further there was a ruling passed by the Advance Ruling Authority on the applicability of GST on penal interest when there is a delayed in repayment of loan.

3.      The case of Bajaj Finance Limited

In case of Bajaj Finance Limited [4](BFL), an advance ruling was passed on 6th August 2018, where it was concluded that penal charges collected by the BFL shall attract GST.

Here it was said that in case of default of payment of EMI by the customer, the applicant tolerated such an act of default or a situation and the defaulting party i.e. the customer was required to compensate the applicant by way of payment of extra amounts in addition to principal and interest. Also, the additional interest is not in the nature of interest but penal charges.

Therefore, the charges levied for any default in repayment of loan will be covered under clause 5(e) of Schedule II of the CGST Act. Also, the same is not an exempt service and will be liable to tax under GST.

4.      Circular no 102/21/2019-GST dated 28th June 2019

Given the numerous queries, the department finally released clarification on the matter. Penal interest charged on delayed payment for supply of goods and services will be included in the value of supply and will stand liable for GST. Whereas penal interest charged on the delayed payment of loan repayment will be exempt under GST.

The clarification given under the notification is discussed at length below.

The various clarifications by the GST Council on additional/ penal interest taxability is represented below in a tabular form:

 

 

FAQs on financial sector

 

 

Notification No. 12/2017-Central Tax (Rate) dated 28th June 2017

 

Case of Bajaj Finance Limited

 

Circular no 102/21/2019-GST dated 28th June 2019

 

Additional interest in case of default payment of instalment in respect of supply, which is subject to GST will be included in the value of supply and therefore liable to GST Consideration by way of interest or discount on deposits loans and advances are considered as exempt service. Charges levied for any default in repayment of loan will be liable to tax under GST.

Penal interest charged on delayed payment for supply of goods and services will be included in the value of supply and will stand liable for GST. Whereas penal interest charged on the delayed payment of loan repayment will be exempt under GST

 

Implication of GST on penal charges

Accordingly, there are different GST implications, which are discussed by way of examples. Financing to a borrower may be done in the following ways:

  • Situation 1: ABC Co (lender/shopkeeper) sells a car to Mr A (borrower) where the selling price of the car is ₹6,00,000. However ABC Co gives Mr A an option to pay the selling price of the car in 24 months (24 instalments) i.e. ₹ 26,250 (Repayment of principal ₹ 25000 + Interest @5% i.e. ₹ 1250). The instalment shall be paid every 10th of the month, and any delay on such payment shall be liable for a penal interest of ₹ 500 per day for delay in payment.

Here the transaction between ABC Co and Mr A is that of supply of taxable goods and not a money to money transaction. The shopkeeper has broken down the payment into tranches referred to as the EMI facility. The said EMI includes interest component as well which is subjected to GST. Also a penal interest is charged on the delayed payment. Accordingly, the interest and penal charges paid on the delayed payments shall be included in the value of supply and as a consequence, it will be under the ambit of GST.

Also this situation will not be covered under clause 5(e) of the Schedule II of the CGST Act. The expression to tolerate an act cannot be said to include a situation wherein penal charges are imposed on the erring party for delayed or non-payment.

Since the above is not covered under serial no 27 of the notification[5], the same is not exempt and taxable under GST.

  • Situation 2: ABC Co sells a car to Mr. A where the selling price of the car is ₹6,00,000. Mr A has an option to avail a car loan at an interest of 12% per annum for purchasing the car from XYZ Co. The term of the loan from XYZ Co allows A, a period of 24 months to repay the loan and an additional /penal interest @1% per annum for every day of delay in payment.

Here the transaction between XYZ co and Mr. A is that of money to money transaction. The penal interest charged will be covered under serial no 27 of notification no 12/2017 Central Tax (Rate) dated the 28.06.2017 “services by way of (a) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services)”is exempted.

Accordingly, in this case, the “penal interest” charged thereon on transaction between XYZ Co and Mr. A would not be subject to GST. The value of supply by ABC Co to Mr. A would be ₹ 6,00,000 for the purpose of GST. Whereas there will no GST charged on the interest and additional/ penal interest charged by the XYZ Co (lender) as the same is considered as an exempt supply.

Therefore, the vendor has the following option to sell the car to the customer:

  • Provide a deferred payment facility by the vendor himself on account of purchase of the car, or
  • Provide a loan facility to purchase the asset through the vendor’s captive lending unit, or
  • Provide a loan facility to purchase the asset through any bank/NBFC

In all the three cases mentioned above, GST taxability will be different. In case the deferred payment facility is provided by the vendor and there is a delay in payment of EMI by the borrower, GST shall be charged on the additional interest due to such delay in payment. However, in case a loan facility has been provided by the vendor’s captive lending unit or by an independent bank or an NBFC, the additional interest charged on the delayed repayment will not be taxable under GST.

Conclusion

The circular by the government came up as a clarification in regard to GST implications on penal charges. This clarification brings ease to various NBFCs who were levying penal charges as per the agreement on the delayed payment of loan instalment. Also, the circular overrides the advance ruling in the case of Bajaj Finance Limited.

To summarise the above discussed concept:

  • Penal charges in case of delayed payment of instalment of supply of goods and services shall be included in the value of supply as per section 15(2) (d) of the CGST Act. The same shall be liable to tax under GST
  • Penal charges in case of delayed payment of instalment of a money to money transaction will be included in the value of supply as per section 15(2) (d) of the CGST Act. The same shall be exempt through serial no 27 of the notification No. 12/2017-Central Tax (Rate) dated 28th June 2017. Therefore penal charges in this case shall not be taxable under GST.

 

[1] http://www.cbic.gov.in/resources//htdocs-cbec/gst/circular-cgst-102.pdf;jsessionid=4085899A448EFF7FCF1762E53BC68D3F

[2][2] http://gstcouncil.gov.in/sites/default/files/faq/27122018-UPDATED_FAQs-ON-BANKING-INSURANCE-STOCK-BROKERS.pdf

[3] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification12-CGST.pdf;jsessionid=3D2C63EDD8A1183AEB262F41985CB224

[4] https://mahagst.gov.in/sites/default/files/ddq/GST%20ARA%20ORDER-22.%20BAJAJ%20FINANCE%20LTD.pdf

[5] [5] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification12-CGST.pdf;jsessionid=3D2C63EDD8A1183AEB262F41985CB224

Union Budget 2019-20: Impact on Corporate and Financial sector

Project Rupee Raftaar: An Analysis

-Kanakprabha Jethani | Executive

Vinod Kothari Consultants Pvt. Ltd.

kanak@vinodkothari.com, finserv@vinodkothari.com

BACKGROUND

The Working Group on Developing Avenues for Aircraft Financing and Leasing Activities in India, constituted by Ministry of Civil Aviation submitted its report[1] on measures for developing this industry in the country. The Working Group was formed to examine the regulatory framework relating to financing and leasing of aircrafts. The idea was derived from the Cape Town convention and it has also been proposed to enact a bill in order to fully implement the convention. This project is based on the theme “Flying for All”. The Indian civil aviation market has been exhibiting tremendous growth for past years. There is an overwhelming increase in demand for passenger transportation for which airlines in India have placed orders for more than 1000 aircrafts. Moreover, Indian airlines have been relying on other countries for financing acquisition of aircrafts on export credit, loan or lease basis. This hair-triggers the need for India to have in place its own systems for financing of such acquisitions.

One of the motivations of the project is to ensure that the dependence of Indian aviation industry on import leases is reduced. Currently more than 90% of the aircrafts operating in the country are on import lease basis, and there is a huge monthly outflow of foreign exchange by way of lease rentals, which is not reported as ECB, since it is an operating expense.

GLOBAL PERSPECTIVE TO AIRCRAFT FINANCING AND LEASING

The key players in global aircraft financing and leasing market are Ireland and the US. Countries like China, Singapore, Hong Kong and Japan are emerging competitors in the market. The structures of aircraft financing, however, differ largely in all of these countries. The overall trends in the global arena can be evaluated on following bases:

Regional Outlook: through a research conducted for the Aviation Industry Leaders Report[2], it was concluded that North America is viewed as the most optimistic market player. Europe shows mixed signals due to market being strong and simultaneous slowing down of economy and other political issues. The Middle Eastern countries show a slow pace of growth and their models exhibit signs of stress. African airline market still has a lot of unrealised potential.

Financing Trends: sale and lease back transactions have become the most frequently used medium of aircraft finance over the world. Other forms of financing such as commercial bank debt, pre-delivering payment financing etc. have picked up pace. Also, traditional forms of financing such as export credit continue to be in operation but with reducing levels. Overall, the capital market remains very active and innovative in the aircraft finance sector.

Technology: new technology in aircrafts is being introduced frequently. However, implementation and commercialisation of the same continues to be a challenge. The Aviation Working Group’s Global Aircraft Trading System (GATS) proposed digitisation of transfer of lease deed ownership system which shall be expected to be activated by end of the year 2019.

CURRENT SCENARIO OF AIRCRAFT FINANCING IN INDIA

In terms of growth and advancement, India is far behind other Asian economies such as China, Singapore and Hong Kong. However, the Indian Aviation market has shown exponential rise in the past few years with an annual growth rate of 18.86% in 2017-18 and overall growth of 16.08% in passenger traffic. From 74 operational airports in 2013, it has reached a height of 101 operational airports in 2016. Expectations of having 190-200 operational airports by the end of 2040 are pointed out through various studies.

Currently, India has large aircraft order books, virtually all of which are leased through leasing companies located offshore. Under the regional connectivity scheme Ude Desh ka Aam Nagrik (UDAN), the government has decide to lease out operations, maintenance, and development of certain airports under Public private Partnership (PPP) model.

Overall, India has immense potential for growth in aviation sector but little means to aid the growth. It is in need of systems that aid the growth in a cost-effective and sustainable manner.

AIRCRAFT FINANCING STRUCTURE

Why is it needed?

In the view of increasing demand and non-availability of own sources of aircraft financing, it is essential for India to set up its own structures for the same. Moreover, civil aviation sector is an important sector for development of the economy. In the civil aviation industry, aircraft financing is the most profitable segment and there are no entities in the country exploring this line of business. All the benefits from this gap are being enjoyed by foreign entities.

What will be the structure?

For this structure, GIFT-CITY in Gujarat has been identified as preferred destination for initiation of operations in this industry as it offers a tax regime competitive to that of leasing companies all over the world.

Barriers in the structure

The aforementioned structure will face following barriers:

  • GAAR prevents Indian financers from taking advantage of other jurisdictions.
  • Aircraft financing is not a specifically permitted activity for banks.
  • Units operating in GIFT-CITY not permitted to undertake aircraft financing.
  • Framework for setting-up of NBFCs in GIFT-CITY and provisions as to treatment of income from operating lease is not provided.
  • Taxes and duties:
  • GST of 5% on import of aircraft
  • GST on lease rentals
  • Interest amount which forms part of lease rentals in case of financial lease is not eligible for any tax benefit.
  • No exemptions from withholding taxes
  • Stamp duty on instruments and documents executed.

The working group has proposed corresponding changes and amendments to be made to overcome these barriers. The response of relevant authorities is awaited.

Tax implications of the structure

Particulars

Tax rates

IFSC-GIFT CITY (proposed structure) INDIA (not following the structure)
INCOME TAX
Corporate Tax Rate: 34.94

o   Year 1 to 5

0.00

o   Year 6 to 10

17.47

o   Year 11 onwards

34.94
Minimum Alternate Tax 10.48 21.55
Capital gains on sale of aircraft 0.00 34.94
Withholding tax

o   Operating lease rentals

0.00 2.00

o   Interest payment (USD debt)

0.00 5.46

o   Interest payment (INR debt)

0.00 0.00

o   Other payments

0.00 10.00
Dividend Distribution Tax nil 20.56
GOODS AND SERVICES TAX
Purchase of aircraft 0.00 0.00
Operating lease rentals 0.00 5.00
Underfinance lease(interest portion) 0.00 5.00
Other services nil 18.00
Stamp duty on lease related documents 0.00 3.00

ANALYSIS OF TAX IMPLICATIONS UNDER VARIOUS MODELS OF FINANCING

Following table shows an analysis of indirect tax implications from the point of view of lessee and compares the proposed structure with the existing practice of financing as well as situation if financing is done outside the proposed structure but in India.

This table is based on following assumptions:

  • Value of aircraft- Rs.3500 crores
  • Residual value- Rs.500 crores
  • Rate of interest- 7.5%
  • Lease tenure- 25 years
  • Processing fee- 2%

On the aforesaid assumptions, lease rental per annum would amount to Rs.306.63 crores

Amount (in Rs. crores)

Tax expenditure Ireland IFSC-GIFT CITY Rest of India
GST on lease rentals 15.3315 0.00 15.3315
Stamp duty 0.00 0.00 105
GST on other services 0.00 nil 12.6
Overall indirect tax expenditure 15.3315 0.00 27.9315

OVERCOMING THE BARRIERS

Recommendations have been made by the Working Group to various regulatory authorities in order to overcome various barriers that are a hindrance to establishment of India’s own structure of aircraft financing and leasing. Following table shows some of the major recommendations:

Authority Recommendations
RBI Confirm that the term “equipment” includes aircrafts or notify aircraft financing and leasing as permitted activity for banks or subsidiaries of banks.
Amend IBU circular to include equipment leasing and investment in capital of leasing entities in scope of activities of banks
Confirm that equipment leasing entities shall be eligible to register as NBFC in IFSC
Issue specific directions in regard to investment in or by foreign entities engaged in aircraft financing and leasing activities.
Tax authorities Capital gains on sale of leased aircrafts should be fully exempted.
GST on leasing aircraft should be made zero-rated.
Nil withholding tax should be specified for airline companies.
Transfer/novation of aircraft financing / leasing contracts to units in an IFSC should not be under the purview of GAAR, for both the lessee and lessor
SEBI Amend SEBI (AIF) Regulations to create a separate category of AIFs for investment in aircraft financing/leasing activities or permit greater concentration of investment in aircraft financing/leasing entities.
Clarify whether 25% investment cap by AIFs applies on investment in equipment and grant additional relaxations to AIFs investing in aircraft financing activities.
Create separate category of mutual funds of investment in entities engaged in aircraft financing and leasing activities.
Clarify which institution can invest in entities registered in IFSC.
IRDAI Amend IRDAI regulations permitting companies set up in IFSC to invest in entities engaged in aircraft financing and leasing activities.
Clarify whether investment of funds of policyholders’ in entities registered in IFSC be considered as funds invested in India only.
Others Clarify under aircraft rules that aircrafts of lessors cannot be detained against any statutory or other outstanding dues.
Entities like pension funds, insurance companies, employee provident fund organisations be allowed to invest directly or indirectly in aircraft financing and leasing activities.
SARFAESI Act not be applicable to aircrafts.
Gujarat Stamp Act to exempt aircraft financing and leasing from its purview.
Permit airlines to set up branch in IFSC.

CONCLUSION

It is absolutely evident that aircraft industry is on upsurge and will continue to be rising globally in the coming years. To meet the rising demand and expand the country’s hold in the aviation market the proposed structure provides a well-established groundwork through the proposed structure. All recommendations, if accepted and implemented in a proper manner, will enable India to pioneer a very profitable and growth-oriented aviation market.

 

[1] https://www.globalaviationsummit.in/documents/PROJECTRUPEERAFTAAR.pdf

[2] https://assets.kpmg/content/dam/kpmg/ie/pdf/2019/01/ie-aviation-industry-leaders-report-2019.pdf

 

Notional income tax on issue of shares by closely held applicable not applicable under Sec.56(2) (vii a), clarifies CBDT

-Million dollar question: Can the same be extended to Sec. 56(2)(x) ?

By Yutika Lohia (yutika@vinodkothari.com)

The abolition of Gift Tax Act in the year 1998 paved way for one of the most dynamic sections of the Income Tax Act, 1961, – Section 56(2). Under this section all kinds of incomes and gains which were from sources other than the sources mentioned in the Act at that time was brought under the purview of Income Tax. Now, incomes and gains arising out of such transactions which were structured to pass on assets to some other party without any consideration or with inadequate consideration was subject to be taxed under this section.

While the Section 56(2) gave the authorities a tool to keep check on the transactions structured to merely launder unaccounted income, it also brought in many questions with itself. The CBDT has since been releasing clarification to address the questions as well as making changes to the section to cover all lose ends of laundering unaccounted incomes.

Recently Central Board of Direct Taxes (CBDT) in its circular dated 31st December, 2018 came up with a clarification to address the question –

Does the terms “receives” with regards to section 56 (2)(viia) include receiving shares of companies (where public are not substantially interested) by way of issues of shares by way of fresh issue/ bonus issue/ issue of rights shares/ transaction of similar nature?

Before we get to the clarification lets first analyse the sections – 56(2)(vii), 56(2)(viia) , 56(2)(viib) & 56(2)(x)

Analysis of Section 56(2)(vii) Section 56(2)(viia) Section 56(2)(viib) & Section 56(2)(x)

Section 56(2)(vii) Section 56(2)(viia) Section 56(2)(viib) Section

56(2)(x)

Applicable to Individual/ HUF Firm/ Company (closely held) Company (closely held) Person as per section 2(31) of the IT Act, 1961
Applicable on 1. Money

2. Immovable Property

3.Property other Immovable Property

Shares of closely held company 1.Issue of Shares 1. Money

2. Immovable Property

3.Property other Immovable Property

Applicable date From  1st October, 2009 to 31st March, 2017 From 1st June, 2010 to 31st March, 2017 From 1st April, 2013 From 1st April, 2017

 

Section 56(2)(viia) of the IT Act, 1961 was inserted by Finance Act, 2010. Referring to the memorandum of Finance Act, 2010[1] clause (viia) was incorporated in section 56 to prevent the practice of transferring unlisted shares at a price which was different from the fair market value (i.e no or inadequate consideration) of the shares and also include within its ambit transactions undertaken in shares of the company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where recipient is a firm or a company (not being a company in which public are substantially interested).

In a layman’s term the act of receiving means to receive something which was already in existence and the act of creation of the that particular thing.

Similarly receipt of shares of shares by way of fresh issue/ bonus issue/ issue of rights shares/ transaction of similar nature is an act of creation of the securities and not transfer of the same. The CBDT in its circular dated 31st December, 2018has clarified the same. section 56(2)(viia) is applicable to transactions involving subsequent transfer of the shares form the initial receiver to some third party, and not time of issuance of such shares.

It is palpable that the shares would be treated as goods only when it comes into existence and issuance of shares is the act of bringing the shares into existence. The word “receives” with respect to section 56(2)(viia) would not include issuance of shares within its ambit.

The intent of insertion of clause (viia) to section 56 was to apply anti-abuse provision i.e transfer of shares for no or inadequate consideration, it is hereby clarified by the CBDT circular that section 56(2)(viia) of the Act shall apply in cases where a company (not being a company in which public are substantially interested)  or a firm receives the shares  of the company (not being a company in which public are substantially interested) through transfer for no or inadequate consideration. Hence section 56(2)(viia) of the Act shall not be applicable on fresh issue of shares by the specified company.

Taxation of fresh issue of shares comes under the purview of section 56(2)(viib).

The Subhodh Menon case in context to Section 56

Recently the Income Tax Appellate Tribunal (ITAT) in the case of The Assistant Commissioner of Income Tax Vs. Shri Subhodh Menon[2], order dated 7th December, 2018 held that a shareholder cannot be taxed under section 56(2)(vii)(c) of the IT Act, 1961 so long as the shares are allotted to the holder on a proportionate basis (right shares), even if such shares are allotted at a value lower than the fair market value.

Drawing from the above case law, right shares issued at a value below the fair market value to individual/ HUF where allotment is disproportionate will not be taxable under section 56(2)(vii)(c) of the IT Act, 1961. Shares issued higher than proportion offered (based on shareholding) shall attract tax provisions.

Conclusion

The Union Budget 2017[3] introduced the section 56(2)(x) of the IT Act, 1961 widening the scope of Income from other sources and also clubbing section 56(2)(vii) & section 56(2)(viia).  Income Tax shall not be chargeable at normal rate for fresh issue of shares for closely held companies.

Since the offence that section 56(2)(viia) was trying to curb is the same as section 56(2)(x), the question still lies, whether the term “receives” clarified in the CBDT circular shall have the same analogy for Section 56(2)(x)? Simply put, whether section 56(2)(x) of the Act will also be limited to transfer of existing shares and not cover fresh issue of shares?


[1] https://www.indiabudget.gov.in/ub2010-11/mem/mem1.pdf

[2] http://itatonline.org/archives/wp-content/uploads/Subodh-Menon-shares.pdf

[3] https://www.indiabudget.gov.in/budget2017-2018/ub2017-18/memo/memo.pdf

Slump sale, a supply of goods or service under GST?

By Yutika Lohia (finserv@vinodkothari.com)

Introduction

India is en-route to turn itself into a 21st century super-economy fuelled by the unprecedented growth of its business enterprises. Business may grow in two ways – either in an organic way or inorganic. The former refers to the internal forces of the enterprises which are re-organised to bring in development and growth into the business, whereas, in case of inorganic growth, the company goes into corporate restructuring to re-align its external facade to fuel the planned development and growth. In today’s fast moving corporate environment, corporate restructuring happens to be the most ideal tool to win an advantage in this pursuit.

Business restructuring is a comprehensive process, be it financial or technological or market or organisational. Business can be re-arranged by way of mergers, demergers, disinvestments, takeovers, strategic alliance or slump sale.

This article focusses on implications of GST on slump sale.

Concept of Slump Sale

The concept of slump sale comes from the Income Tax Act, 1961. The IT Act, in section 2(42C) defines “slump sale” as – “slump sale” means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.”  Further as per explanation 1 to section 2(19AA), “undertaking” shall include any part of an undertaking or a business activity taken as whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.

Therefore, slump sale contains the following conditions:

  • Sale of one or more undertaking,
  • No individual value should be assigned to assets and liabilities, and the same to be sold for a lump sum consideration, and
  • All assets and liabilities of the undertaking must be transferred.

Transfer of all assets and liabilities

One of the major precondition of a slump sale transaction is that all assets and liabilities of the business undertaking must be transferred to the buyer.

As per Section 50B of IT Act, the cost of acquisition of such sale shall be the net worth (book value of assets and liabilities) of the undertaking.

Explanation 1 provides the method of computing the net worth of an undertaking or a division sold on slump sale basis. As per Explanation 1 “For the purposes of this section, “net worth” shall be the aggregate value of total assets of the undertaking or division as reduced by the value of liabilities of such undertaking or division as appearing in its books of account.”  This definition is no different from the meaning of the expression ‘net worth’, as is commonly understood in the accounting parlance.

There are various judicial pronouncements where there is difference of opinion that it is not essential to transfer all assets and liabilities for a transaction to qualify for a slump sale. That is to say, that even if some assets are retained by the transferor and the undertaking after such transfer carries out its business activities without any obstruction, it shall still qualify to be a slump sale. The same has been substantiated by Bombay High Court[1] in its ruling.

Since all assets and liabilities are to be transferred in a slump sale, it is important for one to understand the concept of going concern which is discussed at length below.

Going Concern Concept

The terminology “going concern” is not precisely mentioned in the definition of slump sale. Transfer as a going concern means transfer of a business or a unit which is capable of being carried on by a purchaser as an independent business. To constitute a slump sale, it is not necessary that the business is ongoing at the time of its transfer.

Going Concern is a fundamental accounting assumption and Accounting Standard 1, Disclosure of Accounting Policies defines it as follows:

“The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.”

To constitute a slump sale all the assets and liabilities of the undertaking are to be transferred. Therefore it can be said that companies whose operations are shut and is into liquidation may also opt for slump sale provided the conditions mentioned above are met. The intention of such condition is to ensure that the business will continue in the new hands with regularity and a nature of permanency.\

Further it is not necessary that the entity should be a profit making company. The only valid point to be considered for a transfer to constitute as a “going concern” to mean if it constitutes a business activity capable of being run independently for a foreseeable future. Such views were taken In the Matter of M/S. Indo Rama Textiles Ltd[2]

The term “going concern” has no place in the GST Act. However one can refer to the pronouncement of the Advance Authority Ruling in case of Rajashri Foods Pvt Ltd for the same as mentioned below:\

A going concern is a concept of accounting and applies to the business of the company as a whole. Transfer of a going concern means transfer of a running business which is capable of being carried on by the purchaser as an independent business. Such transfer of business as a whole will comprise comprehensive transfer of immovable property, goods and transfer of unexecuted orders, employees, goodwill etc.

The transfer of business assets implies where the part of assets are transferred and not the whole business, i.e. the liabilities remain in the books of the transferor, whereas in transfer of business all assets and liabilities are transferred together. The concept of transfer of going concern comes handy when the business as a whole is transferred, however case laws and analysis do suggest the likelihood of transfer of assets as a going concern.

Slump sale: supply of good or supply of service under GST Act?

To understand the applicability of GST on a slump sale transaction, it is imperative to throw light on the word “supply” under the GST Act. It is explicitly discussed that for GST to be levied, there must be a case of “supply”. Therefore, we shall now refer the scope of supply as mentioned in Section 7 of the (Central Goods and Services Tax Act 2017 (CGST Act) which is as follows:

“(1) For the purposes of this Act, the expression “supply” includes––

  • all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;”

XX

Supply includes activities such as sale, transfer, barter etc for a consideration in the course or furtherance of business. From this we can infer that the activities shall take place in the course or furtherance of business. Coming to slump sale, the transaction is neither during the course of business nor in persistence of business. However since the word “includes” has been used in the definition in Section 7 (1) of the CGST Act, the scope of supply goes beyond the course or furtherance of business. Therefore the transfer as a going concern shall also be treated as “supply” under GST.

As slump sale is considered to be a supply under GST, we should now understand if the same constitutes to be goods or services.

The term goods has been defined under section 2(52) of the CGST Act as:

“(52)“goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply;”

Further definition of “Service” as per section 2(102) of the CGST Act defines the term service as:

“(102)“services” means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged.”

Clause 4(c) of Schedule II of CGST Act states that

“(c) where any person ceases to be a taxable person, any goods forming part of the assets of any business carried on by him shall be deemed to be supplied by him in the course or furtherance of his business immediately before he ceases to be a taxable person, unless—

            (i) the business is transferred as a going concern to another person; or

             (ii) the business is carried on by a personal representative who is deemed to be a taxable person.”

Schedule II of the CGST Act talks about activities to be treated as a supply of good or supply of service wherein Clause 4, transfer of business assets has been considered as supply of goods. In Clause 4(c ) transfer of business as a going concern does not constitute as supply of goods.

As per the definition of services, anything other than goods is called a service. Business transferred as a going concern is excluded from the list of supply of goods. Since the schedule specifically excludes this activity, it becomes very obvious that transfer of business as a going concern is considered to be a supply of service.

Ministry of Finance vide its notification[3] no 12/2017- Central Tax (Rate) dated 28th June 2017, came out with a list of supply of services and further brought clarity on “service by way of transfer of a going concern, as a whole or an independent part thereof” in serial no 2 of the said notification to constitute under supply of service. Further, activity of transfer of a going concern shall have “nil” rate of tax on such supply.

Since the notification talks about the activity of transfer of a going concern as a supply of service and the same is exempt from the purview of GST. Similarly Schedule II of the CSGT Act excludes transfer of business as a going concern as supply of goods, the same shall be considered as a supply of service and GST shall be levied.

It shall be inferred that transfer of a going concern as a whole or a part there or transfer of business as a going concern is tax-exempt under GST and transfer of business assets will have GST implications.

The above can be further justified by referring to the judgement passed by the Tax Authority of Advance Ruling in Karnataka in the case of Rajashri Foods Pvt Ltd[4] where it was decided that subject to the condition that the unit being transferred is a going concern, it will be considered as a supply of service and the same shall be exempt from the payment of GST to the extent leviable under sub section (1) of Section (9) of the CGST Act, 2017.

Itemisation of assets for levy of GST

In a slump sale, assets proposed to be transferred consist of both movable and immovable property i.e. land, building, stock, plant and machinery etc. Since these assets and liabilities are sold together for a lump sum consideration it does not tantamount to a “mixed supply” under GST.

Let us first understand the concept of mixed supply under GST

Section 2(74) of the CGST Act defines mixed supply as under:

“(74) “mixed supply” means two or more individual supplies of goods or services, or any combination thereof, made in conjunction with each other by a taxable person for a single price where such supply does not constitute a composite supply.”                     

To constitute a mixed supply, there has to be two or more supplies of goods or services and they have be in conjunction with each other. Therefore if the item in the bundle are neither goods nor services, it will not be considered a mixed supply under GST.

Let us understand the same with the help of an example. Suppose the assets being transferred to the buyer are plant & machinery, land and stock for a single price. Here there are more than one good transferred in the transaction. The bundle is not exclusively that of goods or services or both. The same will not qualify to be a mixed supply as land being transferred is excluded from the purview of GST (As per Schedule III of the GST Act which enumerates items which are neither supply of good nor supply of services).

Referring to the above example we may say that all legs of the definition should be satisfied for it to become a mixed supply. Merely because multiple items are sold for a single price should not, by the very fact render them as “mixed supply”. In so far as movable assets being concerned, it would be treated as supply of goods and is likely to attract GST.

Conclusion

Slump sale may be of an on-going business/unit or transfer of a stalled business/unit where the intent of the transferee is to run the entity. It can be said that that when there is a transfer of business and not of that of assets, in order to insulate from GST, it would require evaluation whether transfer is as a going concern or not.

The transaction of transfer of business as a whole of one of the units in the nature of going concern amounts to supply of service. The notification holds good, but subject to the condition that the unit is a going concern and therefore the same shall be free from the GST purview.

To summarise the above discussed concept

  • Transfer of business assets: Supply of goods
  • Transfer of business: Supply of Service
  • Transfer of business/ or a part thereof as a going concern : Supply of service and exempt via notification

Revival of companies will definitely be more cost effective than setting up a new structure altogether. Also this will give a push to the investors to take over such companies and create more job opportunities in India.

 


[1] https://indiankanoon.org/doc/1182478/

[2] https://indiankanoon.org/doc/135651533/

[3]http://www.cbic.gov.in/resources//htdocscbec/gst/Notification12CGST.pdf;jsessionid=D5B61ED295EAEE2B9E0361CAE1525D0F

[4] http://gst.kar.nic.in/Documents/General/06_RAJASHREE_LIMITED.pdf

Taxing Liaison Offices under GST regime

By Simran Jalan (simran@vinodkothari.com)

Introduction

A company resident outside India may initiate business in India by setting up a subsidiary or branch office or liaison office or project office or any other place of business by whatever name called after taking prior approval of the Reserve Bank of India (RBI). Setting up any of the aforementioned place of business has different tax implications. The present discussion focuses on the tax implication on Liaison office under the Goods and Services Tax (GST) regime.

Read more