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SME Listing- win win all!

Introduction

Among all the uncertainties impacting the economy, as regulators are bringing about policy changes, as foreign investors are apprehensive about investing in India– its a sigh of relief for the small and medium sized enterprises(SME), which has a new and easier platform to raise money and advance its growth. SMEs are correctly named as backbone of Indian economy. SMEs contribute 45% of the industrial output, 40% of exports, 42 million in employment, create one million jobs every year and produces more than 8000 quality products for the Indian and international markets.

SMEs till now have been looking at debt options only to raise funds, but they cannot leverage debt beyond a point as they exhaust collaterals. Despite of the priority lending window, raising funds in the capital market has been difficult for most SMEs, given the high costs involved in meeting various compliance requirements.The Prime Minister’s Task Force has recommended to set-up a dedicated Stock Exchange for SMEs. Listing of SME and a dedicated platform for its exchange will facilitate the promotion and development of SME sector and enhance their competitiveness. Listing of securities will help SME sector to raise equity capital as well as create visibility and transparency, thus, corporate governance of a company improves manifold. SEBI has laid down the regulation for the governance of SME Exchange. Both BSE & NSE has announced eligibility norms for listing of companies on its SME exchange launched in the month of March 2012

The relaxed share listing norms issued by SEBI for SMEs will lower some of the barriers for SMEs to enter the stock markets.The norms issued will reduce complaince cost for continuous listing of shares of SMEs,and thus would encourage many more SMEs to borrow the funds from public. As these companies grow bigger, they would migrate to main trading platform and be subject to as much market discipline as any listed company.

BSE on Monday launched its SME bourse fully, with the listing of BCB Finance, a Mumbai-based broking house and NBFC. BCB Finance raised 8.85 crore through an issue of 35.4 lakh shares, which was oversubscribed 1.5 times. The stock listed at 27, or 8% above its post-IPO offer price of 25. BCB is promoted by Uttam Bagri, a member of BSE board. So far, about 50 firms from all accross the country has shown interest to be listed on the BSE SME. Though suspended firms are not allowed to list on the SME exchange, an option is provided to the such firms, which have a paid up capital of less than Rs.25 crore, to migrate to the SME exchange after taking necessary approvals. For suspended companies, these have to first comply with main board norms, get their suspension revoked, get two-third of the shareholders to back the move and then apply to the exchange.

NSE, which has named its SME bourse ‘Emerge’, also announced the filing of the first SME draft red herring prospectus by the Chennai-based Thejo Engineering.

Eligibility Conditions

The eligibility norms announcecd for listing on SME are as follows-
(a)Net tangible assets of at least Rs 1 crore as per the latest audited financial results.
(b)Net worth (excluding revaluation reserves) of at least Rs 1 crore as per the latest audited financial results.
(c)Track record of distributable profits in terms of sec. 205 of Companies Act, 1956 for at least two years out of immediately preceding three financial years and each financial year has to be a period of at least 12 months. Extraordinary income will not be considered for the purpose of calculating distributable profits. Other wise, the networth shall be at least Rs 3 crore.
(d)The post-issue paid up capital of the company shall be at least Rs 1 crore
(e)The company shall mandatorily facilitate trading in demat securities and enter into an agreement with both the depositories.
(f)Companies shall mandatorily have a website

Benefits of Listing of SMEs

Access to capital market for current and future funding requirements
SME sometimes get over-leveraged by borrowing huge funds, through high interest bearing securities leading to high costs. Many a times good ventures fail due to inability to pay off the debts and interest there on. Now, SMEs would be able to access capital markets and raise money at cheaper costs. Further a listed SME can raise finance a number of times, as and when it has requirement of capital, thus capitalise on the opportunity cost of funds.

Liquidity to investors
An investor is generally reluctant to invest in a project where gestation periods are long, in such cases the investor has a high risk and charges high premium on funds. On the other hand the SME finds it difficult to arrange funds for its project at reasonable cost. Listing of SME securities will provide a uniform platform to investors to trade in shares, and enhance the liquidity of such securities. Now, the investor may not be required to hold the securities, until the securities are listed on recognised Stock Exchange.

Regulatory Perspective
So far SMEs have been funded through financial institutions, venture capitalists or PE funds or so. However often there has been concerns by Regulators, for the SMEs where the investors have created undue pressure on the management, and on the other hand where investors are stuck with high investments in a SME project. If SMEs raises money from public, it can mitigate such concerns and still meet their funding requirements. The dedicated exchange for SME securities and easy process of listing will enhance the opportunities available for SME sector. The trading of SME securities will be standardised and governed by regulatory bodies, helping to build up the faith of investors, assume a clean and transparent corporate image.

Conclusion

Entrepreurship and Innovation are the key to succees! The saying though old is still very relevant. SMEs play important role to sustain entrepreurs and promote innovation, allowing small promoters to bring alive there ideas. SMEs become more important as it has helped considerably to control unemployment issues of our country. SME Listing will promote the growth of such entrepreneurs and help us to radicate unemployment and other social issues associated with it. However the promotion of the new concept is still to reach masses, in this context Lakshman Gugulothu, CEO, BSE SME Exchange in an interview says-”We have a bigger challenge of educating promoters of SMEs. The number runs into millions; in every nook and corner of the country. Reaching out to these people and making them aware of the capital market issues is a big challenge. It will take some time and here I think professionals such as CAs and CSs have a big role to play.

Author: Neha Singhi Baid

Contact: +91-22-67477400
neha@nehasinghi.com
Date: May 25, 2012

Minimum Alternative Tax – An overview of issues associated

Legislative history and intent

Minimum Alternative Tax (‘MAT’), inspired by similar levies in the western countries, where the objective for introduction of MAT was to increase the revenue base, was first introduced in the Finance Act, 1987 by virtue of section 115J. Apparently, the levy discriminated between corporate vis-à-vis other entities – partnerships, sole proprietorships, etc and the same is held1 to be constitutional valid and not in violation of Article 14 and 19 under the Constitution of India. The MAT provisions subsequently traveled from section 115J to section 115JA and finally to the existing section 115JB.

Pragmatically, the intent for insertion of MAT in India was to levy tax on the “zero-tax” companies which made profits and distributed dividends but have little or negligible taxable income by virtue of various incentives/ deductions which have been claimed. The intent was reiterated in Memorandum to the Finance Bill, 1996, CBDT Circular No 762 dated February 18, 1998 and Finance Minster’s speech on Finance Act 2000. However, subsequently, contentions based on intent have not been accepted by the Department and it has been held that the provisions of MAT are applicable even in cases where the company has not declared dividend [DCIT vs Samsons Distilleries Pvt Ltd (2009-TIOL-217-ITAT-BANG) and DCW Ltd vs DCIT (ITA No. 4175/Mum/2005)].

Respite to some extent was provided to MAT paying companies by Finance Act, 2005. A tax credit mechanism under section 115JAA was introduced to allow tax credit in respect of MAT paid. MAT liability in excess of the normal tax liability was allowed to be taken as credit in subsequent years under section 115JAA. Currently, such credit can be carried forward and availed for 10 subsequent years.

Key issues and controversies involved

The calculation and methodology for computing MAT which seemed to be simplistic in nature, has been under scanner for legal interpretations. All unresolved controversies related to a number of issues on interpretation of sections 115J and 115JA should prevail for section 115JB as well, since section 115JB is pari material with the earlier provisions. Though numerous issues need to be addressed under MAT provisions, few significant areas of concern are enumerated below:

1. Is it mandatory to furnish Form 29B when the company is not liable to MAT?

MAT liability can be ascertained only after comparing normal tax liability with book profits. Accordingly, provisions of section 115JB(4) provides for obtaining a report from an accountant and Rule 40B and Form 29B provides a format for that. Therefore, it is possible to argue that the report in 29B should be obtained in all cases, irrespective of whether the company is liable to MAT.

Section 115JB (4), to the contrary, inter-alia uses the words “Every Company to which this section applies” – implying report to be obtained only where there is MAT liability. Further, the Act does not stipulate any penalty for not obtaining this report. Section 139(9) also does not consider the tax return to be defective if Form 29B is not obtained.

Hence, there is no explicit downside in cases where a company is not liable under MAT. However, given the legal issues involved in computing the Book Profits under MAT, on a prudent basis, a company should consider safeguarding its risk to the extent possible by getting the MAT computation vetted by a Chartered Accountant.

2. Profits/ gains not routed through Profit and Loss Account. Is it required to include such profits/ gains in Book Profits and offer the same for MAT?

Relying on the Apex Court judgement in the case of Apollo Tyres Limited (255 ITR 0273), judicial authorities have undisputedly held that the AO does not have the power to recast the book profits as arrived in the financial statements except as provided in section 115J if the following conditions are satisfied:

The accounts are prepared in accordance with Companies Act and the same has been audited by the statutory auditor, and his report indicates that the accounts are in accordance with the Companies Act.

The auditor’s report is adopted by the members in the General meeting.

The same is filed with and accepted by the Registrar of Companies.

Companies have therefore taken stand that amounts carried to capital reserves directly (which have not been credited to the profit and loss account) would not be capable of being added back to the book profits for MAT purposes – when the said accounts are duly audited by the statutory auditor, adopted by the members in the AGM and the same is filed with the Registrar. The position has also been blessed judicially in the following cases:

CIT vs Vijayshree Finance and Investment Co, Pvt Ltd2 (Madras High Court)
DCIT vs Indian Syntans Investments (P) Ltd3 (Chennai ITAT)
ACIT vs Vijay Furniture Manufacturing Co. Pvt. Ltd4 (Bombay ITAT)

In this regard, the most important aspect to be noted is the fact that none of the rulings mentioned above have objected to such a treatment in the books of accounts of the assessee, ie whether the tax payers have satisfied the provisions of Accounting Standard 10 and 13. In fact, the Bombay ITAT in the case of Vijay Furniture did not comment on the issue of treatment in books even though the same was the main point of contention of the Revenue authorities.

Pertinently, Bombay HC, in the case of CIT vs Veekaylal Investments Co (P) Ltd 166
CTR 965, have held that capital gains not routed through Profit and Loss account should form part of Book Profits for the purposes of MAT. The same was also re-iterated by Delhi ITAT in the case of Vishwanath Fin Cap (2007-TIOL-241-ITAT-DEL). The ITAT held that, “since the accounts were not prepared by the assessee in accordance with Part II and III of Schedule VI of Companies Act read with mandatory Accounting Standard 13, the AO was competent to re-cast the profit and loss account and re-compute the book profit for the purpose of Section 115JB of the Act.”

Therefore, whether the position adopted by companies would sail at Supreme Court level, even in cases where there is no qualification in the auditor’s report (given the fact that accounting standard interpretation is a matter of professional judgement), remains an unanswered question.

3. How should unabsorbed depreciation and brought forward losses be set off –
Clause (iii) of Explanation to Section 115JB?

The Authority of Advance Ruling (‘AAR’) in the case of Rashtriya Ispat Nigam Limited [2006] 285 ITR 1 has discussed the issues associated with clause (iii) of Explanation to Section 115JB in detail. However, the ruling has not been followed by a number of assessees, specifically in light of the Apex Court judgement in the case of Apollo Tyres, HCL Comnet Systems & Service Ltd (305 ITR 409) and the Tribunal decisions in the case of Sumi Motherson Innovative Engineering Ltd (ITA No 2323/Del/2006) and KFA Corporation Ltd vs JCIT (ITA No 5147/Mum/2002). The challenge is basically on account of the following issues which remain unanswered till date:

(a) Whether comparison of unabsorbed depreciation and depreciation should be made on a year-on-year basis or cumulative basis?

Illustration:

FY

Business Loss

(A)

Unabsorbed depreciation

(B)

Total

Lower of

A or B

1999-2000

18

04

22

04

2000-2001

25

16

41

16

2001-2002

0

11

11

0

Total

43

{31}

74

{20}

As evident from above, if cumulative basis is followed, the amount of brought forward losses and unabsorbed depreciation will be same as the amount brought forward as per the “books of accounts”. Therefore, the same appears to be closer to the language of clause (iii).

(b) How to compute the amount the amount of losses and unabsorbed depreciation to be carried forward, ie whether the tax payer has an option to adjust the losses and unabsorbed depreciation on a pick and choose basis?

Illustration:

Continuing the above illustration, it is further assumed that the Book profits before adjustment under clause (iii) of Explanation to Sec 115JB is –

FY 2002–2003 – INR 6
FY 2003–2004 – INR 32

Though there can be many scenarios which merits consideration in this regard, two possible scenarios are discussed below:

Scenario I

Financial Year

Brought forward Book Loss (before depreciation) – (A)

Brought Forward depreciation

(B)

Total

Benefit claimed

Break-up as on
April 1, 2002

43

31

74

Set off during
FY
2002-03

(06)

06

Amount to be carried forward

43

25

68

Set off during
FY
2003-04

(25)

25

Amount to be carried forward

43

0

43

Potential benefit to be claimed in subsequent years

0

Total benefit claimed

31

Scenario II

Financial Year

Brought forward Book Loss (before depreciation) – (A)

Brought Forward depreciation

(B)

Total

Benefit claimed

Break-up as on
April 1, 2002

43

31

74

Set off during
FY 2002-03

(06)

06

Amount to be carried forward

37

31

68

Set off during
FY 2003-04

(32)

32

Amount to be carried forward

05

31

36

Potential benefit to be claimed in subsequent years

05

Total benefit claimed

43

Scenario I is in line with the advance ruling in the case of Rashtriya Ispat Nigam Limited. However, in the absence of specific suggestion/ prohibition under the Companies Act, or the Accounting Standards, or section 115JB, a tax payer may also be justified in adopting Scenario II.

(c) Whether losses cancelled in the process of corporate re-structuring exercise would still be available for set-off as brought forward losses?

Unabsorbed loss/ depreciation cancelled by book entry against reserves, share premium, etc would not answer the test of having been brought forward as per “books of accounts” in subsequent year. This has also been confirmed by Mumbai ITAT in the case of KFA Corporation Ltd. Therefore, it may be difficult to claim the losses cancelled in the process of corporate re-structuring exercise.

(d) Whether in case of amalgamation the amalgamated company can set-off unabsorbed losses of the amalgamating company?

A view can possibly be adopted that the losses which are brought forward in the books of accounts as on the first day of a accounting year should only be eligible for set-off and therefore, the amalgamated company may not be eligible for such set-offs (unless the amalgamation is effective from the first day of financial year).

However, Bangalore ITAT in the case of VST Tillers & Tractors Ltd vs CIT (2009-TIOL-26-ITAT-BANG) has held that the losses of amalgamating company are available for set-off to the amalgamated company, more so as the amalgamation scheme itself provided for such set-off.

Therefore, if the tax payer incorporates suitable provisions in the merger petition to the Court and pray that the losses of amalgamating company should for all tax assessment proceedings be deemed to have been incurred and recorded by the amalgamated company, the possibility of claiming the losses is greater.

4. Whether MAT credit can be carried forward and utilized by the successor company in case of amalgamation/ merger?

Unlike section 72A, section 115JB or section 115JAA does not contain any specific provision for amalgamations/ merger. Literal interpretation of the provisions of Section 115JAA(1) suggests that the tax credit would be allowed only to the company which had paid such taxes.

SRF Limited vs Garware Plastics and Polyesters Limited [1995] 2 Comp LJ 222 has held that benefits under section 43B would be available to the transferee upon merger. However, given that the Court has just made passing remarks and has not analyzed the allowability of benefits (under Section 43B) in detail, it may not be appropriate to rely on the same. Further, the Apex Court judgement in the case of CIT vs T Veerabhadra Rao [1985] 155 ITR 152, in connection with the right of the transferee company upon merger to recover debts, may also not be of much help.

Therefore, reliance to some extent can be placed on the Bangalore ITAT in the case of VST Tillers & Tractors Ltd and the merger petition can be appropriately drafted, however, in the absence of a specific provision in the Act, it may really be a challenge for the amalgamated company to avail such benefits.

Author: Courtesy

Contact: +91-22-24362234
amit@nehasinghi.com

Date: December 22, 2011

Foreign tax credit – A discussion from Indian context

Interaction of two tax systems, each belonging to a different country, at times results in double taxation of income – economic double taxation or juridical double taxation.

Economic double taxation takes place when the same income is taxed in the hands of more than one person. Juridical double taxation takes place when the same income is taxed in the hands of the same person in more than one jurisdiction. Economic double taxation is typically resolved through bilateral negotiations whereas juridical double taxation is addressed in treaties, typically, through the tax credits article.

Tax credit in India is generally governed by the provisions of a bilateral Double Taxation Avoidance Agreement (‘DTAA’ or ‘the Treaty’) concluded between India and the other contracting state. Further, where there is no DTAA, section 91 of the Indian Income-tax Act, 1961 (‘the Act’) grants unilateral relief in respect of income which has suffered tax both in India and in a country with which no DTAA exists (ie doubly taxed income)1.

We will examine below the different types of tax credit mechanisms under the DTAAs and some key issues/ concepts in relation to tax credit mechanism that merit consideration.

1. Methods for availing tax credits under the DTAAs

Broadly, a DTAA would seek to eliminate juridical double taxation through either of the following two alternative mechanisms:

Exemption method
Credit method

1.1 Exemption method

Under the Exemption method, the State of Residence (‘State R’) does not tax the income, which according to DTAA may be taxed in the State of Source (‘State S’).

1.2 Credit method

Under the Credit method, State R includes income from State S in the taxable total income of the tax payer and calculates its tax on the basis of such taxpayer’s total income (including income from State S). It then allows a deduction from its own taxes for taxes paid in State S.
The Credit method can be applied with several variations –

Ordinary credit method,
Underlying Tax Credit method, and
Tax Sparing credit.

1.2.1 Ordinary credit method

Ordinary credit method refers to allowance of credit, from the tax payable in India, to the extent of tax attributable to the income that has been taxed in State S. The restriction may also be on grant of credit only in respect of income that is taxed in the overseas jurisdiction, ie credit would be granted qua each item of income and only if the same item of income has suffered tax in the overseas jurisdiction. This can be explained with the help of the following illustration:

A Ltd, resident of India – State R, has earned a total income of INR 100,000. Of its total income, INR 20,000 is derived from State S. State R imposes a tax of 35 percent on income of INR 100,000 or more and a tax of 30 percent on income below INR 100,000. State S imposes a tax of 40 percent. In this case, the credit would be computed as follows:

Particulars

Amount (in INR)

Amount of income earned

100,000

State R tax

35,000

State S tax @ 40 percent

8,000

Less: Ordinary Tax credit

7,000*

Taxes due in State R

28,000

Total tax costs

(28000+8000)

36,000

* Under the Ordinary Credit method, the maximum credit is restricted to INR 7,000 (ie 35 percent which is the tax rate in State R on the income earned in State S).

DTAAs executed by India usually follow the ‘Ordinary Credit method’ for elimination of double taxation, for the taxes paid by an Indian resident, either directly or by way of deduction, in the foreign country (State S).

1.2.2 Underlying Tax Credit (‘UTC’) method

UTC is a method to provide relief from the doubly taxed income. UTC refers to the credit that may be given, in a Contracting State (State R), for the tax paid on the underlying profits out of which the dividend is paid by a company in the Other Contracting State (State S).

DTAAs entered into by India (like DTAAs with Mauritius, Singapore) provide for UTC in situations where an Indian company is a shareholder in a foreign company.

1.2.3 Tax Sparing credit

Some of the DTAAs contain “tax sparing” clauses, whereby, tax incentives offered by the particular foreign country (State S) are deemed to have been paid as a foreign tax for the purpose of computing the foreign tax credit granted. Essentially, tax sparing consists of granting a tax credit in a Contracting State (State R) for the amount of tax that would have been payable in the Other Contracting State ie, State S had there been no reduction or exemption under the tax regime of State S.

Few DTAAs with India contain tax sparing provisions, for eg, DTAAs executed with China, Qatar, Singapore (on certain select income streams), Kenya, Philippines, Bangladesh, Korea, Malaysia and Nepal provides tax sparing benefits.

3. Key issues/ concepts in relation to tax credit mechanism

3.1 In cases where tax has been withheld in State S on gross basis, should Ordinary tax credit be claimed on net income basis?

The Ordinary credit method provides for “maximum deduction rule” ie, the deduction cannot exceed the tax liability on the foreign income in State R.

In this regard, paragraph 63 of the commentary of the OECD Model convention states that “The maximum deduction is normally computed as the tax on net income, ie on the income from State E (or S) less allowable deductions (specified or proportional) connected with such income (cf paragraph 40 above).” Further, similar analogy can also be drawn from Rajasthan High Court decision in the case of CIT vs RN Jhangi 185 ITR 586 and CIT vs Dr KL Parikh, though in the context of section 91.

Therefore, Ordinary tax credit is required to be computed on net income basis. Hence, if
State S provides for taxation of income on gross basis, the tax credit in many cases would be lower than the tax effectively paid in State S.

3.2 Can tax credit be claimed against the Minimum Alternative Tax (‘MAT’) payable in India?

Typically, the Ordinary credit method permits credit of tax on the doubly taxed income against Indian tax payable, irrespective of whether the same has been computed as per normal provisions of the Act or MAT. Further, neither the Act nor the Treaty has any specific provision to allow or to restrict the claim of tax credit against MAT.

Therefore, a view could be adopted that tax credit can be availed against MAT. However, the credit should be restricted to the MAT liability. Further, the tax credit in such scenario can be computed based on the following steps (given that the Act or the DTAAs do not specify any method):

Step I – Computation of income subject to tax both in State S and State R

Book Profit in accordance with section 115JB x Turnover/ receipts from State S
Total turnover of the company

Step II – Computation of maximum credit that can be availed

MAT * Income subject to tax both in State S and State R (as per Step I above)
Book Profits in accordance with section 115JB

3.3 Should tax credit be claimed from income-tax including surcharge and cess?

Bangalore Tribunal in the case of Infosys Technologies Ltd vs JCIT 108 TTJ 282 in connection with India-Canada tax treaty has held that,

” … it is made clear that while computing tax on the doubly taxed income, such tax should also included surcharge, as that is also part of tax levied under the provision of the Act.”

Therefore, a view could be adopted that tax credit can be claimed from income- tax (including surcharge and cess).

3.4 Can tax credit be claimed for dividend distribution tax paid under section 115O?

As per the provisions of section 115O of the Act, any amount declared, distributed or paid by way of dividend is subject to Dividend distribution tax (‘DDT’). DDT is neither a withholding tax on dividend income nor a tax on the profits of the company from which dividend is declared.

Under the DTAAs, tax credit is typically available for tax on income (ie income-tax) and/ or for tax on the profits of the company from which dividend is declared (ie UTC). Therefore, tax credit on DDT is per se not available under the DTAAs.

However, credit for DDT can be availed if State R considers DDT as income-tax or underlying tax as per its domestic law. For example, tax credit for 50 percent of the DDT paid in India can be availed, subject to fulfillment of certain conditions, as per the domestic tax laws of Korea. Such credit is also permissible under the domestic tax laws of UK as per certain specific clarifications issued by the Inland Revenue Department of UK.

3.5 How tax credit should be computed under section 91 of the Act when there is income from several overseas countries and loss in India?

The issue is explained with the help of the following illustration:

Company A is a tax resident of India. It carries on business in India, and also in Country X and Country Y, with which India does not have tax treaties. For financial year 2003-04, the amount of net income earned from all businesses, and tax paid in each of the foreign countries is as follows:

Particulars

Country X

Country Y

India

Total

Net income from business/ ‘Total income’

100

100

(-)50

150

Tax Paid in foreign jurisdictions (in accordance with the respective tax conventions)

20

10

Gross income tax liability in India, before Foreign Tax Credit (‘FTC’)

45

The alternative situations that may arise are:

Doubly taxed income from Country X” is Rs 100 (consequent to which a relief of Rs 20 would be available under section 91) and “doubly taxed income in Country Y” is Rs 100 (consequent to which a relief of Rs 10 would be available under section 91) thus resulting a total relief of Rs 30 under section 91.

Doubly taxed income from Country X” is Rs 100 (consequent to which a relief of Rs 20 would be available under section 91) and “doubly taxed income in Country Y” is Rs 50 (consequent to which a relief of Rs 5 would be available under section 91) thus resulting a total relief of Rs 25 under section 91.

Doubly taxed income in Country X” is Rs 50 (consequent to which a relief of Rs 10 would be available under section 91) and “doubly taxed income in Country Y” is Rs 100 (consequent to which a relief of Rs 10 would be available under section 91) thus resulting in a credit of Rs 20 under section 91.

Doubly taxed income in Country X” is Rs 75 (consequent to which a relief of Rs 15 is available under section 91) and “doubly taxed income in Country Y” is Rs 75 (consequent to which a relief of Rs 7.5 is available under section 91) thus resulting in a relief of Rs 22.5 under section 91.

It is interesting to note here that the US IRC attempts to address this eventuality by a combination of regulations, which limit the overall FTC while at the same time clearly focusing on safeguarding any erosion to the tax on US soured income.

3.6 What exchange rate should be considered for the purpose of calculation of the quantum of foreign taxes that are available for FTC?

There is no express provision in the Act on this issue nor is there any judicial precedent or a revenue clarification. The US regulations as well as the treatise by “Klaus Vogel on Double Taxations Conventions”6 suggest that the foreign taxes (as expressed in the foreign currency) have to be converted into the local currency by applying the exchange rate as prevailing on the date on which such foreign taxes are paid.

There could be several situations that may arise in this regard in the Indian context. For example, an Indian resident derives business income of USD 100 in State S (the exchange rate prevailing at this time was 1 USD = Rs 45) and a tax of USD 15 has been paid in State S (the exchange rate prevailing at this time was 1 USD = Rs 46). The business income was realized during the year itself and the exchange rate prevailing at the time of realization was 1 USD = Rs 44. Hence, an issue arises on whether the foreign taxes which are eligible for credit in India have to converted into Indian currency by applying the exchange rate of 1 USD = Rs 44 (prevailing on the date of realization of income in foreign currency) or 1 USD = Rs 45 (prevailing on the date of earning of the income in State S) or 1 USD = Rs 46 (prevailing on the date of payment of tax in State S).
Therefore, the application of this principle to the Indian context is not without doubt.

<p style=”text-align: left;”><span style=”font-size: medium; font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Interaction of two tax systems, each belonging to a different country, at times results in double taxation of income – </span></span><span style=”font-size: medium; font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”>economic double taxation or juridical double taxation.</span></span></span></p>
<p lang=”en-GB”><span style=”font-size: medium; font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”>Economic double taxation takes place when the same income is taxed in the hands of more than one person.  Juridical double taxation takes place when the same income is taxed in the hands of the same person in more than one jurisdiction.  Economic double taxation is typically resolved </span></span></span><span style=”font-size: medium; font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”>through bilateral negotiations whereas juridical double taxation is addressed in treaties, typically, through the </span></span></span><span style=”font-size: medium; font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”><span style=”text-decoration: underline;”>tax credits</span></span></span></span><span style=”font-size: medium; font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”> article.</span></span></span></p>
<p lang=”en-GB”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”> </span></span></span></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Tax credit in India is generally governed by the provisions of a bilateral Double Taxation Avoidance Agreement (‘DTAA’ or ‘the Treaty’) concluded between India and the other contracting state.  Further, where there is no DTAA, section 91 of the Indian Income-tax Act, 1961 (‘the Act’) grants unilateral relief in respect of income which has suffered tax both in India and in a country with which no DTAA exists (ie doubly taxed income)</span></span><sup><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><a name=”sdfootnote1anc”></a></span></span></sup><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>.</span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”>W</span></span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”>e will examine below the different types of tax credit mechanisms under the DTAAs and some key issues/ concepts in relation to tax credit mechanism that merit consideration.</span></span></span></span></span></span>
<p lang=”en-GB”></p>
<p lang=”en-GB”></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”><span style=”text-decoration: underline;”><strong>1. </strong></span></span></span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span lang=”en-GB”><span style=”text-decoration: underline;”><strong>Methods for availing tax credits under the DTAAs</strong></span></span></span></span></span></span></span>
<p lang=”en-GB”></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Broadly, a DTAA would seek to eliminate juridical double taxation through either of the following two alternative mechanisms:</span></span></span>
<ul>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Exemption method</span></span></span></li>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Credit method
</span></span></span></span></span></li>
</ul>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>1.1Exemption method</span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Under the Exemption method, the State of Residence (‘State R’) does not tax the income, which according to DTAA may be taxed in the State of Source (‘State S’). </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>1.2Credit method
</span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Under the Credit method, State R includes income from State S in the taxable total income of the tax payer and calculates its tax on the basis of such taxpayer’s total income (including income from State S).  It then allows a deduction from its own taxes for taxes paid in State S. </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>The Credit method can be applied with several variations – </span></span></span></span></span>
<ul>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Ordinary credit method, </span></span></span></li>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Underlying Tax Credit method, and </span></span></span></li>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Tax Sparing credit.
</span></span></span></li>
</ul>
<p style=”page-break-before: always;”><span style=”color: #000000;”><span style=”font-size: x-small;”><em>1.2.1Ordinary credit method</em></span></span></p>
<span style=”color: #000000;”><span style=”font-size: small;”><span style=”font-size: x-small;”>Ordinary credit method refers to allowance of credit, from the tax payable in India, to the extent of tax attributable to the income that has been taxed in State S.  The restriction may also be on grant of credit only in respect of income that is taxed in the overseas jurisdiction, ie credit would be granted qua each item of income and only if the same item of income has suffered tax in the overseas jurisdiction.   This can be explained with the help of the following illustration:</span></span></span>
<span style=”color: #000000;”><span style=”font-size: x-small;”>A Ltd, resident of India – State R, has earned a total income of INR 100,000.  Of its total income, INR 20,000 is derived from State S.  State R imposes a tax of 35 percent on income of INR 100,000 or more and a tax of 30 percent on income below INR 100,000.  State S imposes a tax of 40 percent.  In this case, the credit would be computed as follows:</span></span>
<table border=”1″ cellspacing=”0″ cellpadding=”7″ width=”300″ bordercolor=”#000000″><colgroup> <col width=”163″></col> <col width=”107″></col> </colgroup>
<tbody>
<tr valign=”TOP”>
<td width=”163″ bgcolor=”#ffcc00″><span style=”color: #000000;”><span style=”font-size: x-small;”><strong>Particulars</strong></span></span></td>
<td width=”107″ bgcolor=”#ffcc00″><span style=”color: #000000;”><span style=”font-size: x-small;”><strong>Amount (in INR)</strong></span></span></td>
</tr>
<tr valign=”TOP”>
<td width=”163″></td>
<td width=”107″></td>
</tr>
<tr valign=”TOP”>
<td width=”163″><span style=”color: #000000;”><span style=”font-size: x-small;”>Amount of income earned</span></span></td>
<td width=”107″>
<p align=”RIGHT”><span style=”color: #000000;”><span style=”font-size: x-small;”>100,000</span></span></p>
</td>
</tr>
<tr valign=”TOP”>
<td width=”163″><span style=”color: #000000;”><span style=”font-size: x-small;”>State R tax </span></span></td>
<td width=”107″>
<p align=”RIGHT”><span style=”color: #000000;”><span style=”font-size: x-small;”>35,000</span></span></p>
</td>
</tr>
<tr valign=”TOP”>
<td width=”163″><span style=”color: #000000;”><span style=”font-size: x-small;”>State S tax @ 40 percent</span></span></td>
<td width=”107″>
<p align=”RIGHT”><span style=”color: #000000;”><span style=”font-size: x-small;”>8,000</span></span></p>
</td>
</tr>
<tr valign=”TOP”>
<td width=”163″><span style=”color: #000000;”><span style=”font-size: x-small;”><strong>Less: Ordinary Tax credit</strong></span></span></td>
<td width=”107″>
<p align=”RIGHT”><span style=”color: #000000;”><span style=”font-size: x-small;”><strong>7,000*</strong></span></span></p>
</td>
</tr>
<tr valign=”TOP”>
<td width=”163″><span style=”color: #000000;”><span style=”font-size: x-small;”>Taxes due in State R</span></span></td>
<td width=”107″>
<p align=”RIGHT”><span style=”color: #000000;”><span style=”font-size: x-small;”>28,000</span></span></p>
</td>
</tr>
<tr valign=”TOP”>
<td width=”163″><span style=”color: #000000;”><span style=”font-size: x-small;”><strong>Total tax costs</strong></span></span><span style=”color: #000000;”><span style=”font-size: x-small;”><strong> </strong></span></span>
<span style=”color: #000000;”><span style=”font-size: x-small;”>(28000+8000)</span></span></td>
<td width=”107″>
<p align=”RIGHT”><span style=”color: #000000;”><span style=”font-size: x-small;”><strong>36,000</strong></span></span></p>
</td>
</tr>
</tbody></table>
<span style=”color: #000000;”><span style=”font-size: small;”><span style=”font-size: x-small;”>* Under the Ordinary Credit method, the maximum credit is restricted to INR 7,000 (ie 35 percent which is the tax rate in State R on the income earned in State S).</span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>DTAAs executed by India usually follow the ‘Ordinary Credit method’ for elimination of double taxation, for the taxes paid by an Indian resident, either directly or by way of deduction, in the foreign country (State S).
</span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><em>1.2.2Underlying Tax Credit (‘UTC’) method
</em></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>UTC is a method to provide relief from the doubly taxed income.  UTC refers to the credit that may be given, in a Contracting State (State R), for the tax paid on the underlying profits out of which the dividend is paid by a company in the Other Contracting State (State S). </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>DTAAs entered into by India (like DTAAs with Mauritius, Singapore) provide for UTC in situations where an Indian company is a shareholder in a foreign company.
</span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><em>1.2.3Tax Sparing credit</em></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Some of the DTAAs contain “tax sparing” clauses, whereby, tax incentives offered by the particular foreign country (State S) are deemed to have been paid as a foreign tax for the purpose of computing the foreign tax credit granted.  Essentially, tax sparing consists of granting a tax credit in a Contracting State (State R) for the amount of tax that would have been payable in the Other Contracting State ie, State S had there been no reduction or exemption under the tax regime of State S. </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Few DTAAs with India contain tax sparing provisions, for eg, DTAAs executed with China, Qatar, Singapore (on certain select income streams), Kenya, Philippines, Bangladesh, Korea, Malaysia and Nepal provides tax sparing benefits. </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”><strong>3.Key issues/ concepts in relation to tax credit mechanism </strong></span></span></span></span></span></span>
<p style=”margin-left: 1.27cm; text-indent: -1.27cm;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>3.1 </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>In cases where tax has been withheld in State S on gross basis, should Ordinary tax credit be claimed on net income basis?</span></span></span></span></span></span></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>The Ordinary credit method provides for “maximum deduction rule” ie, the deduction cannot exceed the tax liability on the foreign income in State R. </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>In this regard, paragraph 63 of the commentary of the OECD Model convention states that </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><em>“The maximum deduction is normally computed as the tax on net income, ie on the income from State E (or S) less allowable deductions (specified or proportional) connected with such income (cf paragraph 40 above).” </em></span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Further, similar analogy can also be drawn from Rajasthan High Court decision in the case of CIT vs RN Jhangi 185 ITR 586 and CIT vs Dr KL Parikh, though in the context of section 91.</span></span></span></span></span>
<p style=”margin-left: 1.27cm;”><span style=”color: #000000;”> </span></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Therefore, Ordinary tax credit is required to be computed on net income basis.  Hence, if
State S provides for taxation of income on gross basis, the tax credit in many cases would be lower than the tax effectively paid in State S. </span></span></span>
<p style=”line-height: 100%;”></p>
<p style=”margin-left: 1.27cm; text-indent: -1.27cm;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>3.2 </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>Can tax credit be claimed against the Minimum Alternative Tax (‘MAT’) payable in India?</span></span></span></span></span></span></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Typically, the Ordinary credit method permits credit of tax on the doubly taxed income against </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>Indian tax payable</span></span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>, irrespective of whether the same has been computed as per normal provisions of the Act or MAT.  Further, neither the Act nor the Treaty has any specific provision to allow or to restrict the claim of tax credit against MAT. </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Therefore, a view could be adopted that tax credit can be availed against MAT.  However, the credit should be restricted to the MAT liability.  Further, the tax credit in such scenario can be computed based on the following steps (given that the Act or the DTAAs do not specify any method):</span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Step I – Computation of income subject to tax both in State S and State R</span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Book Profit in accordance with section 115JB x </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>Turnover/ receipts from State S</span></span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”> Total turnover of the company</span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Step II – Computation of maximum credit that can be availed</span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>MAT * </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>Income subject to tax both in State S and State R (as per Step I above)</span></span></span></span></span></span>
<span style=”color: #000000;”> <span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Book Profits in accordance with section 115JB </span></span></span>
<p style=”margin-left: 1.27cm; text-indent: -1.27cm; page-break-before: always;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>3.3</span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”> </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>Should tax credit be claimed from income-tax including surcharge and cess?</span></span></span></span></span></span></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Bangalore Tribunal in the case of Infosys Technologies Ltd vs JCIT 108 TTJ 282 in connection with India-Canada tax treaty has held that,</span></span></span></span></span>
<span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><em>” … it is made clear that while computing tax on the doubly taxed income, such tax should also included surcharge, as that is also part of tax levied under the provision of the Act.”</em></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Therefore, a view could be adopted that tax credit can be claimed from income- tax (including surcharge and cess).</span></span></span>
<p style=”margin-left: 1.27cm; text-indent: -1.27cm;”></p>
<p style=”line-height: 100%;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>3.4 </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>Can tax credit be claimed for dividend distribution tax paid under section 115O?</span></span></span></span></span></span></p>
<p style=”line-height: 100%;”></p>
<p style=”line-height: 100%;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>As per the provisions of section 115O of the Act, any amount declared, distributed or paid by way of dividend is subject to Dividend distribution tax (‘DDT’).  DDT is neither a withholding tax on dividend income nor a tax on the profits of the company from which dividend is declared.</span></span></span></p>
<p style=”line-height: 100%;”></p>
<p style=”line-height: 100%;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Under the DTAAs, tax credit is typically available for tax on income (ie income-tax) and/ or for tax on the profits of the company from which dividend is declared (ie UTC).  Therefore, tax credit on DDT is per se not available under the DTAAs.</span></span></span></span></span></p>
<p style=”line-height: 100%;”></p>
<p style=”line-height: 100%;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>However, credit for DDT can be availed if State R considers DDT as income-tax or underlying tax as per its domestic law.  For example, tax credit for 50 percent of the DDT paid in India can be availed, subject to fulfillment of certain conditions, as per the domestic tax laws of Korea.  Such credit is also permissible under the domestic tax laws of UK as per certain specific clarifications issued by the Inland Revenue Department of UK.</span></span></span></p>
<p style=”margin-left: 1.27cm; text-indent: -1.27cm;”></p>
<p style=”margin-left: 1.27cm; text-indent: -1.27cm;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>3.5 </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>How tax credit should be computed under section 91 of the Act when there is income from several overseas countries and loss in India?
</span></span></span></span></span></span>
<p style=”line-height: 100%;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>The issue is explained with the help of the following illustration:</span></span></span></p>
Company A is a tax resident of India.  It carries on business in India, and also in Country X and Country Y, with which India does not have tax treaties.  For financial year 2003-04, the amount of net income earned from all businesses, and tax paid in each of the foreign countries is as follows:
<p style=”margin-left: 11.43cm;”><span style=”color: #000000;”> <span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>(Amount in INR)</span></span></span></span></span></p>
<table border=”1″ cellspacing=”0″ cellpadding=”7″ width=”589″ bordercolor=”#000000″><colgroup> <col width=”285″></col> <col width=”70″></col> <col width=”64″></col> <col width=”52″></col> <col width=”46″></col> </colgroup>
<thead>
<tr valign=”TOP”>
<td width=”285″ bgcolor=”#ffcc00″><span style=”color: #000000;”><span style=”font-size: x-small;”><strong>Particulars</strong></span></span></td>
<td width=”70″ bgcolor=”#ffcc00″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><strong>Country X</strong></span></span></span></p>
</td>
<td width=”64″ bgcolor=”#ffcc00″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><strong>Country Y</strong></span></span></span></p>
</td>
<td width=”52″ bgcolor=”#ffcc00″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><strong>India</strong></span></span></span></p>
</td>
<td width=”46″ bgcolor=”#ffcc00″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><strong>Total</strong></span></span></span></p>
</td>
</tr>
</thead>
<tbody>
<tr valign=”TOP”>
<td width=”285″><span style=”color: #000000;”><span style=”font-size: x-small;”>Net income from business/ ‘Total income’</span></span></td>
<td width=”70″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>100</span></span></span></p>
</td>
<td width=”64″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-size: x-small;”>100</span></span></p>
</td>
<td width=”52″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>(-)50</span></span></span></p>
</td>
<td width=”46″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>150</span></span></span></p>
</td>
</tr>
<tr valign=”TOP”>
<td width=”285″><span style=”color: #000000;”><span style=”font-size: x-small;”>Tax Paid in foreign jurisdictions (in accordance with the respective tax conventions)</span></span></td>
<td width=”70″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>20</span></span><sup><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><a name=”sdfootnote2anc”></a></span></span></sup></span></span></span></p>
</td>
<td width=”64″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>10</span></span><sup><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><a name=”sdfootnote3anc”></a></span></span></sup></span></span></span></p>
</td>
<td width=”52″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>-</span></span></span></p>
</td>
<td width=”46″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>-</span></span></span></p>
</td>
</tr>
<tr valign=”TOP”>
<td width=”285″><span style=”color: #000000;”><span style=”font-size: small;”><span style=”font-size: x-small;”>Gross income tax liability in India, before F</span><span style=”font-size: x-small;”>oreign Tax Credit (‘FTC’)</span><sup><span style=”font-size: x-small;”><a name=”sdfootnote4anc”></a></span></sup></span></span></td>
<td width=”70″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>-</span></span></span></p>
</td>
<td width=”64″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>-</span></span></span></p>
</td>
<td width=”52″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>-</span></span></span></p>
</td>
<td width=”46″>
<p align=”CENTER”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>45</span></span><sup><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><a name=”sdfootnote5anc”></a></span></span></sup></span></span></span></p>
</td>
</tr>
</tbody></table>
<p style=”page-break-before: always;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>The alternative situations that may arise are:</span></span></span></p>
<p style=”margin-left: 0.75cm;”></p>
<ul>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Doubly taxed income from Country X” is Rs 100 (consequent to which a relief of Rs 20 would be available under section 91) and “doubly taxed income in Country Y” is Rs 100 (consequent to which a relief of Rs 10 would be available under section 91) thus resulting a total relief of Rs 30 under section 91.
</span></span></span></span></span></li>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Doubly taxed income from Country X” is Rs 100 (consequent to which a relief of Rs 20 would be available under section 91) and “doubly taxed income in Country Y” is Rs 50 (consequent to which a relief of Rs 5 would be available under section 91) thus resulting a total relief of Rs 25 under section 91.
</span></span></span></span></span></li>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Doubly taxed income in Country X” is Rs 50 (consequent to which a relief of Rs 10 would be available under section 91) and “doubly taxed income in Country Y” is Rs 100 (consequent to which a relief of Rs 10 would be available under section 91) thus resulting in a credit of Rs 20 under section 91.
</span></span></span></span></span></li>
<li><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Doubly taxed income in Country X” is Rs 75 (consequent to which a relief of Rs 15 is available under section 91) and “doubly taxed income in Country Y” is Rs 75 (consequent to which a relief of Rs 7.5 is available under section 91) thus resulting in a relief of Rs 22.5 under section 91.</span></span></span></span></span></li>
</ul>
<p style=”line-height: 100%;”></p>
<p style=”line-height: 100%;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>It is interesting to note here that the US IRC attempts to address this eventuality by a combination of regulations, which limit the overall FTC while at the same time clearly focusing on safeguarding any erosion to the tax on US soured income. </span></span></span></p>
<p style=”line-height: 100%;”></p>
<p style=”margin-left: 1.27cm; text-indent: -1.27cm;”><span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>3.6 </span></span><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><span style=”text-decoration: underline;”>What exchange rate should be considered for the purpose of calculation of the quantum of foreign taxes that are available for FTC? </span></span></span></span></span></span></p>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>There is no express provision in the Act on this issue nor is there any judicial precedent or a revenue clarification.  The US regulations as well as the treatise by “Klaus Vogel on Double Taxations Conventions”</span></span><sup><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”><a name=”sdfootnote6anc”></a></span></span></sup><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”> suggest that the foreign taxes (as expressed in the foreign currency) have to be converted into the local currency by applying the exchange rate as prevailing on the date on which such foreign taxes are paid. </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: small;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>There could be several situations that may arise in this regard in the Indian context.  For example, an Indian resident derives business income of USD 100 in State S (the exchange rate prevailing at this time was 1 USD = Rs 45) and a tax of USD 15 has been paid in State S (the exchange rate prevailing at this time was 1 USD = Rs 46).  The business income was realized during the year itself and the exchange rate prevailing at the time of realization was 1 USD = Rs 44.  Hence, an issue arises on whether the foreign taxes which are eligible for credit in India have to converted into Indian currency by applying the exchange rate of 1 USD = Rs 44 (prevailing on the date of realization of income in foreign currency) or 1 USD = Rs 45 (prevailing on the date of earning of the income in State S) or 1 USD = Rs 46 (prevailing on the date of payment of tax in State S). </span></span></span></span></span>
<span style=”color: #000000;”><span style=”font-family: ‘Times New Roman’, serif;”><span style=”font-size: x-small;”>Therefore, the application of this principle to the Indian context is not without doubt. </span></span></span>
<div id=”sdfootnote1″>

Author: Courtesy

Contact: +91-22-24362234
amit@nehasinghi.com

Date: December 22, 2011

[1]Where there is a DTAA, as per the provisions of the Indian income-tax law, relief has to be granted only under such DTAA – CIT v Carew & Co Ltd (1979) 120 ITR 540 (SC).

[2]Assuming a tax rate of 20% in Country X

[3]Assuming a tax rate of 10% in Country Y

[4]In India, it is assumed that tax would be payable @ 30%

[5]Assuming a tax rate of 30% in India

[6]In this regard, Klaus Vogel observes as follows:

Paragraph 61 MC Comm. fails to indicate the rate of exchange to be applied when converting the amount of credit. According to the working – ‘equal’ and ‘egal’- and the purpose of the credit rule, viz. to adjust the set back in wealth suffered as a result of the payment, the only material rate of exchange can be that applicable on the day when the payment was made”.

XBRL: Smart Accounting

XBRL

eXtensible Business Reporting Language

Introduction

XBRL stands for Extensible Business Reporting Language. It is a new global standard of Financial and Business Reporting with an Open Technology. It is used for electronic sharing and communication of business and financial data. It facilitates preparation, analysis and communication of business information. It offers significant cost savings, greater efficiency, accuracy and reliability in use of financial data.

XBRL and XML

The concept of XBRL is developed and derived from XML (eXtensible Markup Language) by international non-profit consortium of companies, organizations and government agencies. XBRL is a flexible version of XML. It provides a standard set of XML tags for exchanging accounting information and financial statements between companies and analysts. It is free of license fees.

XBRL consists of core language of XML elements and attributes. It allows and helps software vendors and programmers to adopt this language for preparation and distribution process. It also helps to enhance, exchange and comparison of business reporting information. The scope of XBRL extends to financial statements, financial information, non financial information, general ledger transaction and regulatory findings, such as annual and quarterly reports.

XBRL with Computers

The computes recognize the data in XBRL document, select it, analyze it, store it, exchange it with other computers and present it automatically in a variety of ways for users. XBRL greatly increases the speed of handling of financial data, reduces the chance of error and permits automatic checking of information.

XBRL in Organizations

All types of organizations can use XBRL. As XBRL is extensible and flexible, it can be adapted to fulfill different requirements. By using XBRL, company and other producers of financial data and business reports can automate the processes of data collection.

Companies can use XBRL to save costs and simplifies their processes for collecting and reporting financial information. XBRL can handle data in different languages and accounting standards. It can flexibly be adapted to meet different requirements and uses. Data can be transformed into XBRL by suitable mapping tools or it can be generated in XBRL by appropriate software.

XBRL Tags

In XBRL information is broken down into unique items of data. These data items are then assigned mark-up tags that make them computer-readable. For example, the tag <Liabilities>100</Liabilities> enables a computer to understand that the item is liabilities, and it has a value of 100.

As XBRL tags are formed in a universally-accepted way, they can be read and processed by any computer that has XBRL software. XBRL tags are defined and organized using categorization schemes called taxonomies.XBRL doesnot treat financial information as a block of text or numeric items, instead it attaches a unique electronically readable tag for each individual financial term.

Taxonomies

Different countries use different accounting standards. Reporting under each standard reflects differing definitions. The XBRL language uses different dictionaries, known as ‘taxonomies’, to define the specific tags used for each standard. Taxonomies are the computer-readable ‘dictionaries’ of XBRL. The taxonomies provide definitions for XBRL tags, they provide information about the tags, and they organize the tags so that they have a meaningful structure.

Taxonomy is made up schema and linkbases. Schema is the set of all the concepts with their XBRL attributes and documentation. All the attributes that required for the XBRL software to understand the meaning of a concept have to be defined. The linkbases provide the relationship amongst the various concepts. While building the taxonomy three broad reporting categories have been considered, taking into account the different reporting requirements. These are:-

1.      Commercial and Industrial

2.      Banking Companies

3.      Non-Banking Finance companies

Ways to create Financial Statements In XBRL

  • XBRL-aware accounting software products are becoming available which will support the export of data in XBRL form. These tools allow users to map charts of accounts and other structures to XBRL tags.
  • Statements can be mapped into XBRL using XBRL software tools designed for this purpose
  • Data from accounting databases can be extracted in XBRL format. It is not strictly necessary for an accounting software vendor to use XBRL; third party products can achieve the transformation of the data to XBRL.
  • Applications can transform data in particular formats into XBRL. The route which an individual company may take will depend on its requirements and the accounting software and systems it currently uses, among other factors.

Banks Submitting Returns to RBI in XBRL

A set of returns for monitoring capital adequacy and other statutory returns have been implemented using XBRL under RBI Act 1934. Rationalises the number of returns to be submitted by banks, thus reduces reporting burden on banks.With the introduction of XBRL, RBI could bring down number of returns from 291 to 225(vide RBI Press Release dated 14 August 2008 and 17 December 2008.)

 

Benefit to a company

  • Increases the utility of financial statement information.
  • The need to re-key financial data for analytical and other purposes can be eliminated.
  • Companies can automate data collection.
  • Reports can be produced with minimum efforts.
  • Removes time-consumption, error-prone processes as well as performs accuracy checks on software.

XBRL in MCA

Circular No. 09/2011.It has been decided by the Ministry of Corporate Affairs to mandate certain class of companies to file balance sheets and profit and loss account for the year 2010-11 onwards by using XBRL taxonomy. The Financial Statements required to be filed in XBRL format would be based upon the Taxonomy on XBRL developed for the existing Schedule VI, as per the existing, (non converged) Accounting Standards notified under the Companies (Accounting Standards) Rules, 2006.

Income tax Department accepts Income Tax Returns in xml format. The data submitted in pdf formats is capable of getting exported to xml.

According to General Circular No. 37/2011 dt. 7-6-2011 XBRL filing is mandatory in a phased manner based on existing Schedule VI. For the companies having balance sheet date on or after 31/03/2011 the last date of filing will be 30th November or 60 days from the date whichever is later.

Coverage in Phase I

The following class of companies has to file the Financial Statements in XBRL Form only from the year 2010-2011:-

(i)All companies listed in India and their subsidiaries, including overseas subsidiaries;

(ii)All companies having a paid up capital of Rs. 5 Crore and above or a Turnover of Rs. 100 crore or above.

Exemptions:-

  • Unlisted Companies
  • Overseas Subsidiaries of Listed Companies
  • Power Companies
  • Insurance Companies
  • NBFCs

Conclusion

XBRL is set to become the standard way of recording, storing and transmitting business financial information. It is capable of use throughout the world, whatever the language of the country concerned, for a wide variety of business purposes. It will deliver major cost savings and gains in efficiency, improving processes in companies, governments and other organizations.

With this XBRL Mandate, analysis of the use of the taxonomies and ability to easily modify them will become critical in evolving the reporting regulations. Companies and finance professionals would need to submit financial data on XBRL format to MCA and MCA would need to verify the data to ensure compliance with structural and reporting guidelines and analyze them quickly and reliably to ensure quality, accuracy and consistency.

Author: Sweta Agarwal

Contact: +91 9883116576, +91 9339906677

swetaagarwal3010@gmail.com

Date: 06 July 2011

FDI Regime: A investor friendly look

Introduction to Draft Press Note on FDI Regulatory Framework

A striking and commendable move by DIPP: to come out with consolidated and comprehensive FDI Regulatory Framework. Foreign Direct Investments by non-resident in resident entities through transfer or issue of security to person resident outside India is a ‘Capital account transaction’ and Government of India and Reserve bank of India regulate this under the FEMA 1999 and its various regulations. Keeping in view the current requirements, the Government comes up from time to time with new regulation, amends/changes in existing one through order/allied rules, Press Notes, etc. The current FDI law is spread over FCRA, FEMA, various circulars, guidelines and press notes; the DIPP has issued about 177 Press Notes, covering various aspects of FDI policy, including cross border investment, policy liberalisation, policy rationalisation and foreign technology collaborations, Industrial Policy. Hence there was a need for consolidation of the FDI policy to make it more transparent, predictable, understandable, simple and clear; thus reducing the regulatory burden and promoting foreign direct investment.

At the very onset, the press note clarifies that it does not make any change in the existing law and any matters not covered in the press note will be continued to be dealt in the manner as under the existing laws. Thus the FDI law is kept intact, and this Press note is an attempt to consolidate the various Acts, Regulations, Press Notes, Press Releases, Clarifications, etc issued and enacted over the past years.

The draft consolidated document released on 24th December 2009 is open for comments until January 31, 2010 and a final document will be released by April 1st 2010. The Government proposes to issue Press Note on FDI Regulatory Framework twice a year in April and October which would be the current regulatory framework on that date; hence incorporating and reflecting all the changes in the regulations during the intervening period of six months. The new system of continuous consolidation and updation is primarily evinced as a measure of investor and investment friendliness.

This Press Note when comes into force will have the effect of rescinding all previous Press Notes on FDI issued by DIPP, and any action taken under the rescinded Press Notes shall in so far as it is not inconsistent with this Press Note be deemed to have been taken under the corresponding provisions of this Press Note.

FDI Regulations: Brief

FDI plays a important role in the accelerated economic growth of a country, and so it does for India which is now fast integrating with the global economy. Over the past years FDI regime has been directed more and more towards liberalisation, allowing free FDI flow in India. The article makes an attempt to capture some of the salient features of the current FDI Regime in a consolidated manner as also reflected in the new draft press note.

Eligibility of Sources of foreign investment

The eligibility criteria for various sources of foreign capital in Indian companies is stated below:

Eligibility of Sources of foreign capital

Eligibility of Resident entities and Instruments

The resident entities which are eligible to receive foreign investment may be classified as follows:

Eligibility of Resident entities and type of instruments

Investments can be made by non-residents in the shares/convertible debentures/preference shares of an Indian company, through two routes; the Automatic Route and the Government Route. Under the Automatic Route, the foreign investor or the Indian company does not require any approval from the Reserve Bank or Government of India for the investment. Under the Government Route, prior approval of the Government of India through Foreign Investment Promotion Board (FIPB) is required.

Investment would be subject to the ‘Previous/existing venture/tie-up condition’. Foreign investment include all types of foreign investments i.e. FDI, investment by FIIs, NRIs, ADRs, GDRs, Foreign Currency Convertible Bonds (FCCB), convertible debentures and preference shares.

Direct and Indirect Foreign Investment

Any non-resident investment in an Indian company is direct foreign investment. An Indian company would have indirect foreign investment if the Indian investing company is owned and controlled by non-residents. An Indian company is said to be ‘Owned and Controlled’ by ‘non-resident entities’, if more than 50% of the equity interest in it is beneficially owned by non-residents or if non-residents have the power to appoint a majority of its directors.

Illustraton for Indirect Foreign investment

The entire investment of Indian company owned and controlled by non residents is considered indirect foreign investment (as demonstrated through Illustration 1), except where the investment is made in a wholly owned subsidiary(WOS) of the Indian company, then the downstream investment in the WOS of such Indian company would be a mirror image of the holding company(as demonstrated through Illustration 2); i.e. if non resident investment in the Indian company is 75%, then the indirect foreign investment in the WOS of Indian company would be 75%.

Any indirect foreign investment would be required to follow the same norms as a direct foreign investment such as entry route, conditionalities and sectoral caps. For the purpose of computation of indirect foreign investment, Foreign Investment in Indian company shall include all types of foreign investments i.e. FDI, investment by FIIs(holding as on March 31), NRIs, ADRs, GDRs, Foreign Currency Convertible Bonds (FCCB) and convertible preference shares, convertible Currency Debentures.

Remittance and Repatriation

The AD Category I bank can allow remittance of sale proceeds/remittance on winding up/Liquidation of Companies of a security (net of applicable taxes) to the seller of shares resident outside India, provided-

  • the security has been held on repatriation basis
  • the sale of security has been made in accordance with the prescribed guidelines and
  • NOC / tax clearance certificate from the Income Tax Department has been produced

Dividends are freely repatriable without any restrictions, subject to Foreign Exchange Management (Current Account Transactions) Rules, 2000, as amended from time to time.

Author: Neha Singhi

Contact: +91-33-40083385

neha@nehasinghi.com

Date: January 15, 2010


[1] Stakeholders include shareholders, creditors, financiers, consumers, government, employees and public at large.

Corporate Governance Voluntary guidelines 2009: A study


Citizens never support a weak company and birds do not build nests on a tree that does not bear fruits” Minister Salman Khurshid quoted Arthshastra while introducing Corporate Governance Voluntary Guidelines 2009 (CGV Guidelines). These guidelines being recommendatory in nature, focus on fairness, transparency, accountability and responsibility by Indian Incorps. CGV Guidelines are set of standard practices which may be voluntarily adopted by the public companies, and big private companies. In the present article we have tried to capture significant policies of the CGV Guidelines and their implications.

The CGV Guidelines suggest guidelines with reference to the below:

I Board of Directors A. Appointment of Directors

B. Independent Directors

C. Remuneration of Directors

II Responsibilities of Board A. Training of Directors

B. Quality Decision Making

C. Risk Management

D. Evaluation of Performance of Directors

E. Board to ensure compliance of law

III Audit Committee A. Constitution

B. Powers

C. Roles and Responsibilities

IV Auditors A. Appointment

B. Certificate of Independence

C. Rotation of Auditors

D. Clarity of Information

E. Internal Auditor

V Secretarial Audit
VI Whistle Blowing Mechanism

An incorporated company has perpetual succession and separate legal identity; but it needs people to run it. The key driver of a company is its management, which includes its Board of Directors (BoD) and key Managerial personnel. A company is run by its management but there are several stakeholders in a company, such stakeholders[1] whose interest is directly or indirectly affected by the performance of company. The stakeholders are dormant and the day to day functions of a company are discharged by its management. The immense powers in the hand of management come along with greater responsibilities, however regrettably constant lapses have been found on the part of management in discharge of their duties and functions. Though there are various statutes and guidelines which govern the management of the company and its functioning, but undoubtedly there are some gray areas yet. Besides advocating transparency and increased disclosures in Annual Report, company’s website, and stock exchange website if company is listed, the guidelines have brought in clarity into certain standard corporate practices such as tenure of Independent Director, remuneration etc. The suggestive guidelines are a further step to strengthen the Corporate Governance framework for Indian Incorps.

Board of Directors

The Board should consist of a balanced combination of Executive Directors and Non-Executive Directors, so as to take a proper and reasoned decision. The Directors are appointed in a company in a General meeting as per the provisions of the Act, however the policies and terms of appointment of a Director vary from company to company and from director to director. The guidelines suggest formal letters of appointment to Non-Executive Directors and Independent Directors, clearly stating the term of the appointment, fiduciary duties, liabilities and remuneration of the appointed Director. The Non-Executive Directors and Independent Directors should be recommended by nomination committee, comprising of majority of Independent Directors including its Chairman. The nomination committee should clearly set out the guidelines  for evaluating the skill, knowledge, experience and effectiveness of individual directors. The Independent Directors should provide a certificate of independence at the time of appointment and thereafter annually. Further to ensure independent approach of Independent Directors, the maximum tenure for Independent Director in a company should not be more than six years, and a period of three years should elapse before such an individual is inducted again in the same company in any capacity. No individual may be allowed to have more than three tenures as Independent Director in a company and the maximum number of pubic companies in which an individual may serve as an Non-Executive Directors/Independent Directors should be restricted to seven. Independent Directors should be allowed to have the option and freedom to meet company management periodically to enable them to study and analyze various information and data provided by the company management.

A Chairman of a company presides over the Board meetings, he has a casting vote in decisions of the Board, whereas Chief Executive Officer(CEO) is incharge of day to day functioning and the management of affairs of the company. Both the positions are senior and helps to provide a check within the top level management. However in a number of Indian companies, the position of Chairman and CEO is enjoyed by the same individual, resulting in unfettered decision making power with a single individual. Thus the guidelines suggest separation of offices of Chairman & CEO, and a clear demarcation of the roles and responsibilities of the Chairman of the Board and that of the Managing Director/CEO such as to promote balance of power .

Remuneration of Directors and senior managerial personnel is an arena which in most vulnerable to  conflict of interest between management and stakeholders. Though there are legal provisions set to govern managerial remuneration, there is a more discipline required through these guidelines which suggest to clearly lay down and disclose Remuneration Policy for the members of the Board and Key Executives. The companies should pay either a fixed contractual remuneration to its Non-Executive Directors, or an appropriate percent of the net profits of the company. The structure of compensation to Non-Executive Directors may have a fixed and variable component based on attendance in Board and Committee meetings. Whereas the Independent Directors should be paid adequate sitting fees(not stock options) which may depend upon the twin criteria of Net Worth and Turnover of companies. The company should form a Remuneration Committee for determining the remuneration of executive directors and executive chairman including compensation payments. The Remuneration committee should consist of at least three members, majority being non executive directors with at least one being an Independent Director. Further no director is to be involved in deciding his or her own remuneration. The committee should also determine principles, criteria and the basis of remuneration policy of the company and any deviation from such policy, should be brought to the notice of shareholders with justification/reasons.

Responsibilities of the Board

  1. Generally the Non-executive Directors and Independent Directors do not take active part in the day-day functioning of the company and may not be aware of the technical and operational details. The companies should have a proper induction program for Directors, also providing adequate training to familiarise them with the operational aspect of the company.
  2. The Board should ensure that there are systems, procedures and resources available to ensure that every Director is supplied, in a timely manner, with precise and concise information in a form and of a quality appropriate to effectively enable/discharge his duties. The Directors should be given substantial time to study the data and contribute effectively to Board discussions.
  3. The Board, its Audit Committee and its executive management should collectively identify the risks impacting the company’s business and document their process of risk identification, risk minimization, risk optimization as a part of a risk management policy; and should make disclosure in the Directors’ Report..
  4. A formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.
  5. The Board should place systems to ensure Compliance with Laws, to safeguard shareholders’ investment and the company’s assets. It should review of the effectiveness of the company’s system of internal controls and should report to shareholders.

Audit Committee of Board

Section 292A requires every company with a paid up capital not less than five crores to have a Audit Committee to ensure compliance of internal control systems. Listing agreement has also provision for Audit Committee, which is applicable to listed companies. Now, the guidelines also suggest that the companies should have at least a three-member Audit Committee, with Independent Directors constituting the majority. The Chairman of such Committee should be an Independent Director. All the members of audit committee should have knowledge of financial management, audit or accounts. The Audit Committee should have the responsibility to –

  • monitor the integrity of the financial statements of the company;
  • review the company’s internal financial controls, internal audit function and risk management systems;
  • make recommendations in relation to the appointment, reappointment and removal of the external auditor and to approve the remuneration and terms of engagement of the external auditor;
  • review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process.
  • monitor and approve all Related Party Transactions including any modification/amendment in any such transaction.

Auditors

The Statutory Auditors of a company verifies and states that the financial statements of the company reflect a true and fair view of the state of affairs of the company. The Auditor acts as a watchdog and protect the interest of the stakeholders. The CGV Guidelines suggest appointment of Auditors should be referred by the Audit Committee. Every company should obtain a certificate of independence from the auditor certifying his/its independence and arm’s length relationship with the client company.

Since the havoc created by Satyam episode in December 2008, where the leading audit firm failed to check deep irregularities in the financial statements of a giant IT company leading to fraud of billions of rupees of a publicly listed company, there has been constant attempts to make and implement a rule for rotation of Auditors. The CGV Guidelines suggest that a policy of rotation of auditors should be adopted where a Audit partner should be rotated once every three years, whereas an Audit firm may be rotated once every five years. A cooling off period of three or five years should elapse before a partner or audit firm respectively, can resume the same audit assignment.

Further to strengthen the independence and credibility of the internal audit process, an internal auditor should be appointed, not being an employee of the Company.

Secretarial Audit

Good corporate governance practices enhance companies’ value and stakeholders’ trust; hence it is essential to ensure transparent, ethical and responsible governance of the company. A company can ensure standard corporate governance practices through Secretarial Audit by an Independent Professional.

Institution of mechanism for Whistle Blowing

The term whistleblower derives from the practice of English (policemen), who would blow their whistles when they noticed the commission of a crime. The whistle would alert other law enforcement officers and the general public of danger. In corporate parlance, whistle blowing is a mechanism for employees to raises a concern about wrongdoing occurring in an organization or body of people, such as suspected fraud or violation of the company’s code of conduct or ethics policy. The guidelines suggest to set up whistle blowing mechanism to track frauds or non-violation occurring in the company. However it is also essential to have adequate safeguards against victimization of employees who avail the mechanism.

Conclusion

“Good corporate governance practices are a sine qua non for sustainable business that aims at generating long term value to all its shareholders and other stakeholders”. It is strong fundamentals and ethical behavior in a company that can help it overcome huge crisis. Compliance with good governance practices should not be regarded as regulatory requirement but rather as an opportunity and value proposition for organisations. Investors all around the world notice companies with clean governance, and this appreciation leads to higher valuation of such organisation. The CGV Guidelines is a benchmark for the corporate governance practices in the Indian Incorps, and hopefully the corporate world will make the best use of it.

Author: Neha Singhi

Contact: +91-33-40083385

neha@nehasinghi.com

Date: January 8, 2010


[1] Stakeholders include shareholders, creditors, financiers, consumers, government, employees and public at large.

Salient Points of First Discussion Paper on Goods and Service Tax

Bringing about a change in the indirect taxation system of India, the concept of Goods and Service Tax is presented for discussion. We have listed down below the salient features of the first discussion paper on GST

  1. A dual GST structure: Central GST and State GST; tax to be paid to the Accounts of Centre and State separately
  2. Input Tax Credit for Central GST only available against Central GST, and the same  rule applies to State GST; cross utilization of ITC allowed between the Centre and State only in case of interstate supply of goods
  3. Centre and State to have separate legilation; each state may have its one legislation keeping basic provisions of chargeability, levy, classification unifor to the maximum extent possible
  4. Thresholds proposed: State GST Annual Gross Turnover 10 lacs and Central GST 1.5 crores
  5. Following Central and State Taxes are proposed to be subsumed:
    • Central Excise Duty, Additional Excise Duties
    • The Excise Duty levied under the Medicinal and Toiletries Preparation Act
    • Service Tax
    • Additional Customs Duty, commonly known as ountervailing Duty (CVD)
    • Special Additional Duty of Customs – 4% (SAD)
    • Surcharges, and
    • Cesses
    • VAT / Sales tax
    • Entertainment tax (unless it is levied by the local bodies)
    • Luxury tax
    • Taxes on lottery, betting and gambling
    • State Cesses and Surcharges in so far as they relate to supply of goods and services
    • Entry tax not in lieu of Octroi
  6. Inter-state Goods and Service Tax Model: Centre would levy IGST (CGST plus SGST) on all inter-State transactions of taxable goods and services. The inter-State seller will pay IGST on value addition after adjusting available credit of IGST, CGST, and SGST on his purchases. The Exporting State will transfer to the Centre the credit of SGST used in payment of IGST. The Importing dealer will claim credit of IGST while discharging his output tax liability in his own State. The Centre will transfer to the importing State the credit of IGST used in payment of SGST.
  7. GST Rate Structure expected
  8. Special rate for precious metals
    Lower rate for necessary items and goods of basic importance
    Standard rate for goods in general
  9. Zero rating for exports
  10. Both CGST and SGST will be levied on import of goods and services into the country. Full and complete set-off will be available on the GST paid on import on goods and services.

Author: Neha Singhi

Contact: +91-33-40083385

neha@nehasinghi.com

Date: November 11, 2009

An era of transformation in law

Discussion on the recent changes in Indian Corporate legal environment

Indian Regulators are sitting on the edge, recreating and revamping the legal framework for Indian Incorporations. Significant alterations have been due from long time; however owing to the rigidity of Indian legal system the process have been outstretched. But better late than never!!!! Call it for the fall of Lehman Bros in Sept 2008, recession in world economy, Satyam scam in Dec 2008, or crunch in Indian business, the Regulators are finally here making a difference to the Indian Corporate Sector by making the law healthier and easier.
law for corporatesIndia is one among the top developing countries with incredible growth history and favorable economic conditions. The Country’s Commerce & Industry is on an ever-changing spree, competing on a world-wide scale. The gigantic pool of resources, diverse options of income, enormous consumer market warrants growth potential in India. Exports in the country have increased with leaps and bounds and India is sought as one of the favorable avenue of investment by international investors. The business and number of corporate organizations have increased manifold over the years. In this dynamic era, one cannot think of sticking to age-old legal regime. A legislation which is too old will lose its relevance and jeopardize the objective for which it was enacted. India has stretched its arms to a new constitutional framework governing its body corporate to meet the requirements of changes globally.
We shall briefly discuss here, the forthcoming changes, both certain and expected, in Indian legal regime:

  1. International Financial Reporting Standards
  2. The International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) are increasingly being recognised as Global Reporting Standards. More than hundred countries, including the countries of the European Union, Australia and Russia, currently require the use of IFRSs in their countries. The implementation of IFRS would help Indian companies to speak the same accounting language as their foreign counterparts in countries like UK, Canada, Singapore and Australia.

    In view of the globalisation, uniformity in accounting statements for companies all over the world had become a necessity. India proposes full convergence of Indian accounting standards with the IFRS by April 1, 2011. The framework states that the objective of financial statements is to provide information about the financial position, performance and changes in the financial position of an entity that is useful to a wide range of users in making economic decisions, and to provide the current financial status of the entity to its shareholders and public in general. Adopting IFRS will be a major challenge for Indian Companies, but undoubtedly will reap benefits in the long run.

  3. Goods and Service Tax
  4. The Finance Ministry has declared introduction of Goods and Services Tax (GST) by the year 2010 in India. France was the first country to introduce GST, and now more than 140 countries are already following GST taxation system. GST would replace the principal broad-based consumption taxes i.e. CENVAT and the Service Tax levied by the Centre and the VAT levied by the states. GST is basically tax on final consumption, to be levied concurrently by both levels of government. The GST will work as a centralised taxation system with collection of all the Tax going to the Central Government and then shared by the states.

    Goods and Service Tax is a tax on goods and services, which is leviable at each point of sale or provision of service, in which at the time of sale of goods or providing the services the seller or service provider can claim the input credit of tax which he has paid while purchasing the goods or procuring the service. While the white paper of GST is yet to be released, there is a lot of speculation on the exact model to be introduced in our country.

  5. Direct Tax Code
  6. taxA brand new Direct Taxes Code (code) has been released that will replace the 1961 Income Tax and other direct tax laws, when adopted by the Parliament in the winter session. The code is a complete rewriting of Indian tax regime; radically improvising on the taxation structure by making it simpler and thus warranting better compliance.

    The thrust of the code is to improve the efficiency and equity of taxation system by eliminating distortions in the tax structure, introducing moderate levels of taxation and expanding the tax base. The attempt is to simplify the language to enable better comprehension and remove ambiguity to foster voluntary compliance.

    The code’s thrust on clarity, certainty and an effective dispute resolution is quite commendable, and should go a long way in boosting India’s image as a friendly investment destination. All the direct taxes have been brought under a single code and compliance procedures unified. This will eventually pave the way for a single unified taxpayer reporting system. The separate concepts of ‘previous year’ and ‘assessment year’ are replaced by a unified concept of ‘financial year’. The provisions relating to capital gains taxation have been altered, such as any investment asset transferred at gain is taxable for the respective assessee, removing the concept of short-term and long-term gain; further sale of any business asset will be considered as business income and taxed accordingly, thus heavily impacting mergers and acquisitions. The Securities Transaction Tax (STT) is proposed to be abolished and the gain or loss arising out of sale of securities or units is proposed to be taxed as capital gain. The code moderates income tax rates, such as the tax rate up to an annual income of Rs 25 lakh is just 20 per cent, additional tax benefits are extended to women and senior citizens. Corporate tax rate for both foreign and Indian companies is proposed at 25%, however an additional branch profit tax of 15% on after tax income for foreign companies has been proposed. Even though the corporate tax rate is lowered, minimum alternate tax at 2% of gross assets without deducting liabilities will be a huge blow to the dream of paying less tax by corporate houses. The Direct Code is under review and the comments and critics are being made, hopefully the resulting law meets the aspirations of all, in the country.

  7. Company Bill 2009
  8. The Companies Bill 2009 was introduced by the Finance Minister in Lok Sabha on 3rd August 2009. The new bill is a clone of Company Bill 2008, with the only difference of Bill and Republic year. Even though some major episodes occurred during the transition period of the two Bills, Regulators have not modified the provisions of the earlier bill; hence ignoring the demands of changed times of corporate sector. The Bill introduced with a purpose “to consolidate and amend the law relating to companies”, has focused on structural and some procedural changes in law. A list of provisions of listing agreement has been incorporated in draft company law, irrespective of the fact that a separate statutory body, SEBI, is governing such provisions, does it invite for dual governance and conflicting approach of MCA and SEBI over these provisions? There has been only a vague attempt to simplify the language or bring more clarity in legal provisions. The most sought feature, i.e. more autonomy for corporate following more transparency, and impetus for self driven corporate governance has been missing in the draft company law….

    Important provisions like Section 383A requiring appointment of Company Secretaries or compliance certificate from Whole-time Practicing Company Secretaries have been arbitrarily removed. Shorter process and single forum for approval of mergers and acquisitions is recognised, however the advantage is mainly to merger of holding and wholly owned subsidiaries or among small companies having paid up capital and turnover less than amount as specified. Law makers have missed the fact that simpler language and conceptual clarity is more required than mere structural changes and add or less of certain provisions. Indian corporate structures are unique in its own way, with majority of companies being closely held. We would certainly need more revamping of provisions and making the law more user friendly for attracting more compliance and at the same time promoting growth.

  9. Revision of Takeover Code
  10. SEBI had come out with Substantial (Acquisition of Shares and Takeover) Regulations way back in 1997, almost a decade ago. The 12-member Takeover Regulation Advisory Committee (TRAC), set up on September 4, is likely to look into the entire takeover code address issues related to norms for overseas acquisitions, creeping acquisitions, increasing the threshold for open offers, and non-compete fees. The new takeover code which is probably more reflective of thinking on revitalizing the takeover code and being more responsive to institutional investors and the sentiment around the world where large institutional investors want to have a say in how things are done.

Apart from the above legal and regulatory changes which are in pipeline, there have been few changes which have already taken place such as enactment of Limited Liability Partnership Act, 2008, coming of SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009 (ICDR Guidelines). Probably, the law makers want to tone up the legal statutes to meet the demands of time, and we are hopeful that the results are constructive, and build up India’s image as a law compliant nation. A simple and friendly law will be credible by all Indians as well as foreign countries who propose to invest in India.

Author: Neha Singhi
Contact: +91-33-40083385
neha@nehasinghi.com
Date: October 20, 2009

Limited Liability Partnerships

Apple pie for maturing service industry in India


CONCEPT OF LLPs:
Limited Liability Partnerships can be defined as an alternative to the traditional partnerships and can most appropriately be described as a hybrid between a company and a partnership that not only provides the benefits of limited liability but allows its members the flexibility of organizing their internal structure as a partnership based on a mutual agreement arrived between them. Owing to flexibility in structure and operation, LLP are very much suitable for small enterprises and venture capitalists. Also it provides a platform to professional firms of Company Secretaries, Chartered Accountants, Advocates etc. to conduct their business/professional activities under the organisation structure recognised as separate legal entity, limiting their personal liability and increasing their global competitiveness.

INTERNATIONAL SCENARIO OF LLPs:
Internationally, LLPs are a very popular form of business but slightly vary from country to country. I .In United States , Limited partnerships emerged in the early 1990s; while only two states allowed LLPs in 1992, over forty had adopted LLP statutes by 1996, when LLPs were added to the Uniform Partnership Act (UPA) . Each individual state has its own law governing their formation. Although found in many business fields, the LLP is an especially popular form of organization among professionals, particularly lawyers, accountants and architects.

In the United Kingdom, The Limited Liability Partnership is a recent innovation of UK law, and has been introduced by the Limited Liability Partnerships Act 2000. The Act became law on 1st April 2001. In a LLP, all partners have limited liability, similar to that of the shareholders of a corporation. The partners have the right to manage the business directly and and they bind the firm by their actions. From the taxation perspective also LLPs are favourable since many countries have a different level of tax liability on partnership and LLP firms as compared to a corporation. Under UK law, the LLP is a “fiscal transparency, means that it is not subject to taxation and the only the members are liable to taxation.

degreeINTRODUCTION OF LLPs IN INDIA:
The unlimited liability of partners has so far been the primary reason for which Partnership Firm of professionals, have not grown in size to successfully meet the challenges posed by international competition,WTO,GATT etc. Much as an alternative to the traditional partnerships, Limited Liability Partnership structure was given a recognition through Limited Liability Partnership Act, 2008 . Limited Liability Partnership Bill, 2006 was introduced in Rajya Sabha on 15th December 2006 by Minister of Companies Affairs. The LLP Bill, 2006 introduced was broadly based on the UK and Singapore LLP Acts. The Bill was later referred to Department Related Parliamentary Standing Committee on Finance for examination and report. Keeping in view the recommendations made by the Standing Committee and other relevant inputs, the Government finalized the LLP Bill, 2008. On 21st October, 2008, the revised Bill was again introduced in Rajya Sabha and it finally got passed on 24th October 2008. Later, the Bill was passed by Lok Sabha on 12th December, 2008, and received President’s assent on 7th January 2009, and thus Limited Liability Partnership Act, 2008 came into force.

The main provisions or the highlights of the Act are as follows:

  1. Any two or more persons,by subscribing there names to the incorporating document and after filing it with Registrar can form a LLP.
  2. The LLP shall be a body corporate and shall have a separate entity different from its members.
  3. The LLP shall have a perpetual succession means that the corporation or organization would continue to exist despite of death, bankruptcy, insanity, change in membership or an exit of a partner.
  4. While the LLP has a separate legal entity, liable to the full extent of its assets, the liability of the partners would be limited to their agreed contribution in the LLP. No partner would be liable on account of the independent or unauthorized actions of other partners, thus allowing individual partners to be shielded from joint liability created by another partner’s wrongful business decisions or misconduct.
  5. Indian Partnership Act,1932 shall not be applicable to the LLP and unlike traditional partnerships where maximum number of partners cannot exceed 20, there shall be no such upper limit in case of LLP.
  6. Every LLP shall have at least two partners and shall also have at least two individuals as Designated Partners, of whom at least one shall be resident in India. The duties and obligations of Designated Partners shall be as provided in the law.
  7. The mutual rights and duties of partners of an LLP inter se and those of the LLP and its partners shall be governed by an agreement between partners or between the LLP and the partners subject to the provisions of the LLP Act 2008. The act provides flexibility to devise the agreement as per their choice. In the absence of any such agreement, the mutual rights and duties shall be governed by the provisions of Schedule I of LLP Act.
  8. An audited Annual Accounts are required to be maintained by every LLP reflecting a true n fair view of its state of affairs. In addition to this a statement of accounts and solvency shall also be filed by every LLP with the Registrar every year.
  9. The Central Government has powers to investigate the affairs of an LLP, if required, by appointment of competent Inspector for the purpose.
  10. A firm, private company or an unlisted public company is allowed to be converted into LLP in accordance with the provisions of the Act. Upon such conversion, on and from the date of certificate of registration issued by the Registrar in this regard, the effects of the conversion shall be such as are specified in the LLP Act.
  11. The winding up of the LLP may be either voluntary or by the Tribunal to be established under the Companies Act, 1956. Till the Tribunal is established, the power in this regard has been given to the High Court.
  12. The law would confer powers on the Central Government to apply such provisions of the Companies Act, 1956 to provide, inter-alia, for mergers, amalgamations, winding up and dissolution of LLPs, as appropriate, by notification with such changes or modifications as deemed necessary. However, such notifications shall be laid in draft before each House of Parliament for a total period of 30 days and shall be subject to any modification as may be approved by both Houses.

BRIEF PROCESS OF INCORPORATING A LLP IN INDIA

  • Minimum two of the partners have to obtain a Designated Partner Identification Number by applying in Form 7 on the LLP website. A physical set of documents along with valid proof are sent to the Department for validation.
  • Name Availability Form 1 has to be filed by two designated partners.
  • Once name availability is confirmed then, Incorporation Form 2 has to be filed stating the details of the partners. A proof of the registered office has to be attached with the form.
  • Information with regard to LLP Agreement has to be filed with in one month of Incorporation in Form 3
  • Consent of partner to become a partner/designated partner has to be filed in Form 4 within one month of incorporation.

LLP Process
** this picture is an extract from the LLP website (http://www.llp.gov.in/)

RESPONSE TOWARDS LLPs BY THE INDIAN MARKET:
The rules in respect of registration and operational aspects under the LLP Act, 2008 viz. LLP Rules, 2009, were issued on 1st April, 2009. The rules in respect of conversion of a partnership firm, a private company and an unlisted public company into LLPs were made effective w.e.f. 31st May, 2009. The Government also launched a website namely www.llp.gov.in on 1st April,2009 for registration and governance of LLPs.

This introduction of LLPs in Indian Market was taken hand to hand and consequently a bullish response was seen. The first LLP got registered on 2nd April,2009,the very next day of the issue of rules regarding LLPs and as by the current data , till 5th October 2009,the registered number of LLPs has increased up to 248.

TAXATION ISSUES:
The Union Budget 2009 announced on July 6, 2009 the road map for the taxation of the LLPs in India. The new provisions introduced in relation to the taxation of LLP do not treat the LLP as a transparent entity but treat the same at par with the general partnerships under the Indian Partnership Act, 1932. Accordingly, the profits and losses of the LLP would not pass
through in the hands of the partners but would be assessable in the hands of the LLP. The definition of “firm”, “partner” and “partnership” under section 2(23) of the Income Tax Act, 1961 (‘IT Act’) have also been extended to include LLP, a partner in a LLP and LLP respectively within their scope. Accordingly, all the provisions relating to the partnership firm apply mutatis mutandis to LLPs.

LLPs have also been excluded from the provisions of section of 44AD of the Income Tax Act, which provide for an option of the income of the general partnerships to be taxed at a presumptive rate of 8%. A new section 167C has been introduced in the IT Act, which makes every partner of a LLP jointly and severally liable for the taxes to be paid by the LLP for the period during which he is a partner, unless the non-recovery of taxes cannot be attributed to gross neglect, misfeasance or breach of duty on his part.

Some of the key highlights of tax on LLPs are as follows:

  • LLPs will be treated as Partnership Firms for the purpose of Income Tax w.e.f. assessment year 2010-11 .
  • No surcharge will be levied on income tax.
  • Profit will be taxed in the hands of the LLP and not in the hands of the partners.
  • Minimum Alternate Tax and Dividend Distribution Tax will not be applicable for LLP.
  • Remuneration to partners will be taxed as “Income from Business & Profession”.
  • No capital gain on conversion of partnership firms into LLP.
  • Designated Partners will be liable to sign and file the Income Tax return.

Thus all the aforesaid factors make LLP an attractive mode of business so far as the tax cost is concerned.

GLOBAL COMPARISON:
Comparison of legal regime of Indian LLP with United States and United Kingdom LLP:

S. No Particulars United States LLP Indian LLP United Kingdom LLP
1. Registration with required authority

Registration with Secretary of the States.

Registration with Registrar of Companies required.

Registration with Companies House required.

2 Document of Registration

Form LLP-1

LLP Agreement

LLP Agreement

3. Distinct entity

Is a separate legal entity under the Uniform Partnership Act ,1996. Each Individual States have passed Revised Uniform Partnership Act 1997 to implement LLP in their own states. It means LLP legislation in one specific states is different from other

Is a separate legal entity under the Limited Liability Partnership Act, 2008

Separate legal entity under the Limited Liability Partnership Act, 2000, operating under a combination of partnership and company law.

4. Name of Entity

Name to contain ‘Limited Liability Partnership’ or ‘LLP’ /RLLP as suffix

Name to contain ‘Limited Liability Partnership’ or ‘LLP’ as suffix

Name to contain ‘Limited Liability Partnership’ or ‘LLP’ as suffix

5. Foreign Partnership

Foreign Nationals can be a Partner in a LLP. Atleast one of the designated partner should be resident in India

Foreign Nationals can be a Partner in a LLP.

Foreign Nationals of any nationality can be a Partner in a LLP, further all the partners may be foreign nationals

6. Liability of Partners/Members

Limited to the extent of their contribution towards LLP. In case of fraud or omission LLP is liable for partners wrongful act

Limited to the extent of their contribution towards LLP, except in case of intentional fraud or wrongful act of omission or commission by the partner

Limited, to the extent of their contribution towards LLP

7. Maintenance of Statutory Records

Required to maintain books of accounts

Required to maintain books of accounts

Required to maintain books of accounts

8. Annual Filing

Annual Return must be filled with the Secretary of States

Annual Financial Statement and statement of Solvency is required to be filed with Registrar of Companies every year.

Annual return to be submitted to the Registrar of Companies every year

9. Borrowing by LLP

Borrowing Resolution is passed by the partners to take a decision

As per LLP Agreement

LLP can borrow money in its own name

10. Winding Up

By filing Form LLP-4 with the Secretary of States

Voluntary or by order of National Company Law Tribunal.

As per Regulations by applying or incorporating, with or without modifications provisions of Insolvency Acts.

CONCLUSION:
LLPs have been in rising trend in various other countries such as UK, USA, Australia, Singapore, China, Japan, Germany etc. In this form of business entity, the individual partners are relieved from joint liability of partners in a partnership firm and there liability does not extend to their personal assets. Indian service industry is expanding its horizons, there are a large number of Indian professionals exporting services all over the world. The recognition of LLPs will make them more competitive in International world, and augment the growth of service industry in India. Professionals like Company Secretaries, Chartered Accountants, Cost Accountants, Advocates and others may form multi-disciplinary LLPs to meet the limit their liabilities and grow in the changing economic environment. This hybrid structure of LLP facilitates entrepreneurs, service providers and professionals to constitute, organize and operate in a most efficient and effective manner so as to face the competition in the global market. Indeed the LLP structure will sooner become the most common form of organisation among professionals, and contribute to Corporate World at large.

Author: Anjali Hemrajani

For Neha Singhi & Company
Contact: +91-33-40083385
anjali@nehasinghi.com
Date: October 2009

Covered Bonds: A Primer

Global Finance Market

The US economy is going through a doom, and it goes without saying that it has impacted the entire world’s financial market. The month of September 2008 has witnessed colossal plunge in the finance market. Top investment giants have been nailed down; the fourth largest investment bank of the world: Lehman Bros. filed for bankruptcy, sale of Merill Lynch to Bank of America; and AIG Inc raising money to survive. The market sentiments have become vulnerable; everybody is left guessing what next?? Though regulators are now making efforts to stabilize the market; but it is highly unpredictable and disruptive atmosphere.

The Asset backed securities (ABS) which had once witnessed a leap and bound rise, is set on a decline now. Until year 2007, a ‘Triple A’ rated bond was as good as a covered bond, but it is not the same anymore. The troubles of ABS market have made the investors more cautious and choosy. Now use of covered bonds as means of raising cheap finance is rising fast.

Covered Bonds call of the day: “Closer to the age-old concept of secured lending; and running parallel to securitisation”

As the financial market is facing a decline, a not so new mode of raising finance is on a rise. It can be said that Covered bond is only a new anatomy for the generic concept of secured lending. It owes all its basic attributes to secured lending however also reap some benefits from the concept of asset backed funding. The idea is to get the best features of the two modes of funding and develop a new means to raise finance that suits the investor’s appetite.

Investor’s choice changes with time, and so has to be with the nature of securities offered to them. Quite sometime back, it was plain simple secured lending; then there was a gush for sophisticated structured products of asset backed funding; now the buzzword for the day is Covered Bonds! Though Asset based funding is nonetheless relevant, however with the downturns of the risk appetite of investors- Covered Bonds will find a more favorable market.

Europe has been the first one to introduce covered bonds in the market in the form of mortgage bonds or pfandbriefs. Certain US issuers also have used covered bonds, the first one being issued by Washington Mutual in September 2006. However, developing countries are yet to come in terms with this change.

Unique features of Covered Bonds

Certain features of covered bonds are as follows:

No off balance sheet funding: The underlying assets continue to remain on the balance sheet of the originator¹. There is no transfer of assets to a bankruptcy remote entity as in the case of asset backed funding. The issuer of bonds continues to hold the portfolio of assets, and carries the risk of default.

Dual Recourse: A very significant and distinct feature of Covered Bonds is that in the event of default of the loans, the bondholders have recourse against the pool of loans over which security has been created and also against the issuer.

Desired Rating: Inspite of the fact that the rating of covered bonds can be highly influenced by the rating of the issuer, the rating of the Covered Bonds is usually higher than that of the issuer. Issuing covered bonds can also fetch the desired rating for the securities since dual recourse against the pool of assets and highly regulated financial institution enhances the credit rating of the bonds. Further overcollateralisation, third party guarantee can be some of the other forms of credit enhancements in case of Covered Bonds.

Dynamic Pool: The cover pool of assets is mostly dynamic, i.e. the issuer can change the make-up of the loan pool to maintain its credit quality, which can benefit investors. The issuer can also change the terms of the loans thus continuing to control the underlying assets. The pool of assets is separable in case of insolvency of issuer for the benefit of the bondholders, such that the bondholders have first and foremost recourse to the pool of assets.

Multiple Issues: A very unique feature of covered bonds is that from a common pool of cover assets, more than one issue can be made. The issues may or may not rank pari passu in respect of the charge on the underlying assets, and hence may seek rating according to the pool cover.

Market of Covered Bonds

Europe being the senior most in the run has been leading with the maximum issues of covered bonds. Undoubtedly US have also geared up to experiment covered bonds with the changing investor’s behavior. The idea is yet to sink in with issuers in several countries, and there is a likelihood that the market for covered bonds in other parts of world will catch up soon. The financial regulators are also doing their bit in promoting covered bonds and reviving investor’s faith.

Germany has been the topnotch in issue of covered bonds with the maximum amount of outstanding covered bonds over more than 10 years. Spain and France are also inclined towards use of covered bonds. The market of covered bonds is illustrated through the below pictures² :


Legal Regime

Most of the European countries have their own separate set of law governing issue of covered bonds, stating the eligible underlying assets, priority right of bondholders etc. US Treasury came up with Best Practices guidelines on covered bonds referring to two options for their issue: the direct issue of covered bonds by the issuer holding the cover pool assets on its balance sheet and an indirect issue through the creation of a special purpose vehicle.

However no specific legislation exists in most of the non-European countries that have ventured into covered bonds, such countries operate mostly under a contractual framework. Uniform Commercial Code (UCC) provides the legal background for creating a first-priority security interest over pledged assets, thus providing the broad legal background for issue of Covered bonds in countries which have no specific legislation for the same.

Is India ready for Covered Bonds?

Witnessing the low in the markets, it’s quite likely that issuers will resort to alternate and more attractive means of raising finance. However lack of understanding may pose a hindrance in the growth of the covered bonds. Further covered bonds also lack some of the attractive features of asset backed funding, such as: capital relief, off balance sheet treatment for accounting purposes, isolation of pool of assets from issuer, limiting the risk of the issuer etc. It might be less attractive to issuers however it is undoubtedly more appealing to investors especially when the sentiments of the market are significantly low.

Author: Neha Singhi
Contact: +91-33-40083385
neha@nehasinghi.com
Date: October 2008

¹Originator here refers to the entity holding the portfolio of assets securing the covered bonds

²Extracted from Fitch report “ABCs US Covered Bonds” dated September 3, 2008