Companies Act 2013 is a landmark legislation and is likely to have far-reaching consequences on all companies operating in India. The new Act, which has been in the making for 10 years, has been enacted by the government in parts with few sections already effective and balance yet to be notified. The draft rules are in the midst of a consultation process.
At first glance, it seems that the Companies Act 2013 aligns with the tax laws since it mandates that every company would follow the year ending on March 31 as its financial year. However, a closer look at the Act throws up various inconsistencies with the Income Tax Act 1961.
Tax deductibility of CSR expenditure
The hotly-debated and actively-publicised corporate social responsibility provisions have been recently notified to be effective from April 1, 2014. The law as notified provides that companies that exceed a specified net worth/turnover or net profit are required to mandatorily spend 2% of their average net profit towards specified CSR activities. With the net profit threshold limit at R5 crore, a large chunk of companies are likely to come under the CSR net.
However, a key issue that is troubling the tax manager at every large corporate is the absence of any specific provision for deductibility of such CSR expenditure under the income tax laws. Under section 37 of the
Income Tax Act, expenditure incurred exclusively for the purpose of business is allowed as a deduction. Relying on few judicial precedents, it may be argued that the expenditure incurred on account of a statutory obligation ought to be deductible; however, the fate of this argument may be uncertain without clear provisions in the law.
Under the CSR rules, a company can undertake CSR activities through a registered trust, registered society or a company established under section 8 of the new Companies Act. Further, the specified CSR activities are defined in schedule VII of the new Companies Act. However, such specified activities currently do not align with the definition of charitable purpose under the Income Tax Act. As an example, though the issue of promotion of gender equality and empowerment of women which is a growing trend in India now finds a mention in the Companies Act; however, the same is not covered under the provisions of the Income Tax Act.
Tax implications of revision of accounts
Under section 130 of the new Act, the central government, income tax authorities, Sebi or any other statutory authority, or any concerned person can make an application to the Tribunal or Court for restatement of financial statements where it believes that the accounts of the company were prepared in a fraudulent manner or the companys affairs were mismanaged. The Board of Directors can also voluntarily obtain approval from Tribunal or Court for restatement of accounts under section 131 of the new Act. The voluntary revision is restricted only to preceding three years, whereas there is no time restriction for revision initiated by a statutory regulatory authority. Revision of financial statements for a period earlier than immediately preceding financial year may impact the financial statements for subsequent years also.
Such revision of financial statements may have tax implications in relation to minimum alternate tax (MAT) liabilities as a result of change in the reported profits. As MAT is computed at a specified percentage on the adjusted book profits of the company, the company may be required to file a revised income tax return for the relevant previous year. As per section 139(5) of the Income Tax Act, a company can furnish a revised return only up to the expiry of one year from the end of the relevant assessment year. Hence suitable amendments may be required in the tax law permitting the revision of the income tax return beyond such period where the financial statements are revised in accordance with section 130 or 131 of the new Companies Act.
Tax neutrality for cross-border merger
The prevalent law in India only permits the merger of foreign company into an Indian company and does not allow the vice-versa. The new Companies Act, under section 234, makes a bold move by permitting such cross border mergers even of Indian companies into a foreign company; even though with various restrictions such as RBI approval, merger being permitted only with notified jurisdictions, etc.
Here the Income Tax Act, however, needs to adapt to the upcoming change since currently the tax neutrality provisions for amalgamations under section 47 are applicable only where the amalgamated company, i.e., the transferee is an Indian company. Without corresponding tax neutrality being granted to mergers of Indian companies overseas, these cross-border merger provisions may remain theory with no practical application. In fact, the foreign exchange regulations also need a corresponding alignment with this liberal move under the new Companies Act.
Treatment of related party transactions
Section 188 of the new Act has increased the reporting and compliance requirements for related party transactions while simultaneously widening the definition of a related party. It further provides that all such transactions have to be made at arms length price.
The definition of related party under the new Act and the tax laws currently do not align. Further, the methodologies and approaches for determining the arms length transactions have not been prescribed in the 2013 Act but the same do exist under the transfer pricing provisions of the tax law. Currently, in the Income Tax Act, the domestic transfer pricing provisions cover specified deductible items such as payment made to a related party in respect of expenditure incurred; however, with the increased focus on such transactions, possible amendments in the provisions can be expected to introduce full-fledged domestic transfer pricing.
The new Companies Act, 2013, has given wider powers to the income tax authorities through provisions such as the power to call for revision in the financial statements, mandatory notifications of every scheme of arrangement etc. However, it also calls for the tax authorities to make consequent amendments in the income tax law. The recent actions of the Sebi Board to align the corporate governance norms for listed companies with those prescribed in new Companies Act could be a precedent that the tax authorities should follow. We can hope that the above tax issues are dealt with in the upcoming budget in July.
The author is partner, International & M&A Tax, KPMG in India. Views are personal