Certain Tax Terms & Meaning

Certain Tax Terms & Meaning

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Service tax on construction

The construction industry is growing rapidly, mirroring the overall growth in the economy. Services in relation to construction, repair or reconditioning of commercial and residential complexes fall within the ambit of service tax.

The Budget 2007 brought works contract services under the service tax net, and provided for levy of service tax on all integrated construction services and turnkey projects where VAT is also payable. These services are already covered under other specific taxable services and their scope has not been amended till date. This has created an ambiguity in classification of construction services as they can be classified as both ‘construction of commercial property/ residential complex service’ or ‘work’s contract service’.

A circular issued recently prohibits transition in respect of ongoing contracts from an earlier classification to Works Contract Services. For all future contracts, a service provider has the option to utilise a composition scheme or abatement in the taxable value when the services relate to construction.
used in the course of providing renting of commercial property services.

“The ambiguity in the classification of construction services into one of the categories needs to be resolved. There should be only one service under which works contracts should be classified with no ambiguity. The credit system also needs to be streamlined with clarity on availability of credits on input and input services under various schemes,” says Bipin Sapra, Associate Director.

“The clarification needs to be revisited as construction services are an eligible input for the renting of immovable property as they are used in the setting up of the premise from which the service is provided.”

Securities Transaction Tax

In 2004, the Finance Minister, P. Chidambaram, introduced Securities Transaction Tax (STT). Every transaction in securities entered into in a recognised stock exchange in India attracts STT, including transactions in stock, index options and futures.

At present, STT ranges between 0.017 per cent to 0.25 per cent and is leviable on taxable securities transactions in equity shares, derivatives and units. The rate of STT varies in case of derivatives, futures, and other taxable securities transactions. The responsibility to collect STT from the purchaser or seller vests in the stock exchange or a mutual fund. Rebate in respect of STT is also available against income-tax where income is charged to tax as business income.

STT has been a tool to collect taxes and counter speculation by operators without affecting long-term investors. The surge in stock markets has earned the revenue department a 57 per cent rise in STT collections to Rs 5,895 crore up to December 2007 compared with approximately Rs 2,908 crore in the same period in the last fiscal.

STT is currently levied on all transactions in the secondary market effected through the stock exchange. Corporates have been coming out with buyback and open offers which are not subject to STT since such transactions are executed outside a recognised stock exchange. Such transactions have tax implications affecting the sale transaction. The Budget could seek to expand the ambit of STT to such off-market transactions in listed securities.

“The securities lending scheme permits entities to borrow and lend securities to facilitate short selling. Although the definition of a taxable securities transaction for the purpose of levy of STT refers only to a purchase and sale of securities on a recognised stock exchange (which a lending and borrowing is not) it would be useful if the Budget confirms this point,” says Hiresh Wadhwani, Partner.

Venture Capital Funds

Venture capital funds (VCFs) provide an avenue to investors to participate in a wider range of investments than may be feasible for an individual investor. With a view to encouraging the setting up of pooled vehicles for risk capital financing which can then be channelised into companies in need of capital, the Finance Act, 2000, accorded a pass-through status for income earned by SEBI registered VCFs subject to meeting certain conditions.

This tax treatment of VCFs was consistent with the globally accepted approach for taxation of investment vehicles designed to avoid double taxation of income, that is, to ensure that income is taxed only once in the hands of the investors.

Last year’s Budget restricted the pass-through status to income earned by VCFs from investments in nine specified sectors. In practice, the amendment should not impact a vast majority of VCFs set up as trusts which in any case enjoy a pass-through status under the general provisions of the Act subject to the trust qualifying as a determinate trust and its income not being regarded as business income.

The amendments will also not have any impact on foreign VCFs which are generally set up in tax favoured jurisdictions - for example, Mauritius.

“However, there is a lack of clarity on the practical application by the tax authorities of the above general provisions for taxation of VCF trusts. It would therefore be necessary to either reinstate the pass-through status to VCFs generally on all income earned or alternatively clarify that VCFs would be liable to pay tax equal to the aggregate tax that would have been paid by the investors individually,” says Hiresh Wadhwani, Partner, Financial Services.

“Towards this, it would be necessary that the law be suitably amended to provide the conditions for qualifying a VCF trust as a determinate trust keeping in perspective the manner in which VCF trusts are structured.”


Banking Cash Transaction Tax (BCTT) was introduced as an anti-tax avoidance measure with an objective of providing a mechanism to check unaccounted money through a trail of cash withdrawal transactions.

BCTT is chargeable on cash withdrawn from an account in any scheduled bank (other than savings account) or cash received on encashment of term deposits from any scheduled bank where the cash withdrawn/received exceeds Rs 50,000 per day for an account held by an individual or HUF and Rs 1,00,000 per day for other account holders. Rate of BCTT is 0.1 per cent of cash withdrawn/received.

There have been serious objections against BCTT, especially from the business entities which are required to withdraw large sums of cash for genuine purposes, for example, payment of cash salaries, stamp duty and other regular business expenses. BCTT has also invited serious concerns from banks since it has added considerable administrative burden on them to maintain the records of collection and payment of tax, filing returns, undergoing assessment proceedings, to name a few instances.

The Finance Minister has stated that BCTT has proved to be a useful tool to track unaccounted monies since it has led the revenue authorities to many money laundering and hawala transactions.

“BCTT is not a revenue generating levy which is clear from the fact that it constitutes only about 0.2 per cent of total direct tax collections so far. It was intended to be a temporary measure until other systems to track black money and money laundering cases are in place,” Sameer Gupta, Partner.

“Under the income-tax laws/money laundering regulations banks are obligated to furnish comprehensive information on the cash transactions. Therefore, it would be more efficient to obtain the relevant data on cash withdrawals through such information collation framework rather than by administering a separate levy like BCTT.”

Customs Duty - Shipping Industry

The shipping industry in India has traditionally enjoyed a favourable Customs duty regime. In the last decade or so not only have the peak Customs duty rates steadily come down to nil but also the list of items relating to the shipping industry which are now subject to nil rate of Customs duty has increased to include almost everything of relevance.

Not only ships but also vessels of various other kinds, such as barges, tugs, pusher crafts and dredgers and the spare parts of the same, are also now exempted from levy of Customs duty.

However, notwithstanding a favourable Customs duty regime, there are certain long-standing issues affecting the industry. The Government would do well to address the same in the upcoming Budget. World over, the stores carried by ships are not subjected to any kind of domestic taxes. The rationale behind this exemption being that such supplies tantamount to exports as the same are consumed on ships on high seas and thus should be zero rated. However, in India the stores, including edibles, fuel etc., are still subject to levy of domestic taxes such as VAT and excise, etc. This increases the cost of services provided by the shipping industry in India and puts them in a disadvantageous position vis-À-vis their foreign counterparts.

Although the parts required for repair of ships are exempt from levy of Customs duty, the ship repair equipment itself imported by the shipping companies is still subjected to Customs duty. This increases the cost of repairs and dilutes the advantage of cheap labour cost in Indian ship repair yards.

“An impetus for the shipping sector could be operationalisation of SEZs for shipping companies. This would require certain policy decisions by the Government for allotment of additional land at the ports. This move would make the services of the shipping companies including ship making and repairing very competitive,” says Manu Verma, Associate Director.

“The industry has also been demanding simplification of port procedures once a ship enters the port. The present procedure of filing voluminous documentation should be replaced by a self-declaration procedure so that the unloading operations can begin immediately without having to wait for clearance from the Customs authorities.

Excise duty on automotive sector

Typically, the Government would like to keep the auto industry robust because it also affects transportation of goods in the country. As part of the rationalisation of duty rates, the Government has brought down the excise duty rates from a whopping 40 per cent in 2001-2002 to 16/24 per cent in 2007-08.

The last time when the Finance Minister intervened in the industry was in the Budget two years ago when he cut the excise duty on small cars to 16 per cent.

Also with effect from June 1, 2006, MRP-based valuation has been introduced for automobile parts and spare parts. The present abatement of 33.5 per cent on MRP is allowed for calculation of excise duty.

At present, passenger vehicle (other than small car) attracts excise duty at the ad valorem rate of 24 per cent.

Two and three wheelers are liable to 16 per cent excise duty. Maxi cabs with seating capacity up to 13 passengers and motor vehicles for transportation of goods with petrol engine are liable to excise duty of 24 per cent

Additionally, 1 per cent NCCD (National Calamity Contingent Duty) which was introduced in March 1, 2001, would also apply. Also, while introducing NCCD, it was initially planned only for one year. Because of this, a manufacturer has to maintain separate accounts. NCCD levy increases the product cost by 1 per cent with multiple tax rates.

“The expectation of the automobile industry from Budget 2008 is more on rationalisation of duty and tax rates and less on procedural matters. The demand of the industry would be to eliminate tax inefficiencies on the input side and also lower duty/tax rate on some category of finished vehicle,” says B. Sriram, Associate Director. “With competitive pricing being the mantra at least in lower segment of this industry, cascading taxes would not help. On the auto ancillary front, competition is imported from outside the country through reduced Customs duty generally and also through specific Free Trade Agreement with South-East Asian countries. The demand of the industry would be for a level-playing field.”

Technology - Service Tax

With the liberalisation of the Indian economy and the consequential growth in the services sector, the Union Government introduced the levy of ‘service tax’ in 1994, to claim its share of the “services pie”. An estimated Rs 40,000 crore in service tax revenue is expected to be collected in the current fiscal year.

The growth of the Indian IT/ITES sector over the years has been phenomenal with India emerging as a leading player in the “offshore services” space and contributing significant foreign exchange to the exchequer. Companies in the IT sector are engaged in providing a wide range of services, key amongst which are software engineering and related IT services.

The Government recognised the contribution of this sector to the economy and excluded computer software engineering and related IT services from the purview of service tax. However, the Export of Services Rules only provide for rebate/refund of service tax paid on input services used for export of “taxable” services.

The IT sector is facing challenges on availability of Cenvat credit and consequent rebate/refund of taxes paid on input services consumed for export of such IT services which are treated as “non-taxable”. This, coupled with a strong appreciation of the rupee against the dollar, has resulted in cost escalations for the industry at one end and a disparity vis-À-vis the benefit available to other export oriented industries (including ITES Sector) eligible for a refund/rebate of input service tax, on the other.

“Given the evolving nature of the service tax legislation and nascent provisions with regard export of services, Cenvat credit, rebate/refund of taxes, it is only reasonable to expect that the Government should appreciate the need for rationalisation of the legislative framework with specific emphasis on the IT services sector,” says Vivek Pachisia, Senior Manager - Indirect Tax.

“The coming Budget should be focused on clearing up the anomalies with regard to availability of Cenvat credit and rebate/refund of input taxes for all service exporters, including the IT sector, which, besides providing relief to the IT Sector would also align the incentive with the stated objective of export promotion.

Dividend Distribution Tax

Dividend distribution Tax (DDT) on mutual funds, which was introduced by the Finance Act, 1999 is here to stay as it has become a sizeable revenue earner for the exchequer.

At present, DDT is levied only on income funds - at the rate of 20 per cent for distribution to a corporate and 12.50 per cent for distribution to a non-corporate. To promote a safer vehicle for investment in equities and keeping in mind the fact that equity dividends are subject to DDT, the law provides for exemption from DDT for equity funds.

The Finance Act, 2007 had brought about a further distinction between liquid fund/money market mutual funds vis-À-vis other types of income funds, and a higher DDT rate of 25 per cent was introduced on such funds, apparently with a view to check the tax arbitrage available to persons with short-term surpluses investing in such funds.

There are no specific provisions in law relating to taxation of Fund of Fund (FoF) schemes - a unique product from the mutual fund industry which seeks to achieve further risk diversification by investing in schemes of various fund houses. In the absence of specific provisions, such schemes also face the brunt of DDT even when the FoF is invested largely in equity funds.

According to R Anand, Partner, “Introduction of different DDT rates depending on the characteristics of the income scheme has resulted in fiscally-introduced differentiation within various categories of income funds, which is avoidable. There is therefore a need to restore parity in DDT rate for all types of non-equity funds.”

“Further, taxing of FoF schemes which in-turn invest in other equity schemes is against the intention of sparing equity investments from DDT. It is therefore appropriate that FoFs that satisfy investment criteria of being ultimately invested in equities, be brought on a par with normal equity schemes of mutual fund and extend the exemption from DDT to such schemes.”

FBT - impact on technology companies

The Government introduced the Fringe Benefit Tax (FBT) regulations in the Finance Act, 2005. The rationale for the levy was to tax collective benefits enjoyed by the employees; such benefits were otherwise not subject to tax.

The FBT legislation has been extended to all categories of employers (including foreign employers), barring a few approved trusts, funds, institutions, hospital and registered political parties. FBT is payable on the value of the fringe benefits provided or deemed to have been provided by an employer to his employees during the relevant financial year at the rate of 30 per cent (plus applicable surcharge and cess).

Considering the difficulties faced by the employers in understanding this legislation, the Central Board of Direct Taxes issued a circular in August 2005 in the form of Questions and Answers, and addressing 107 queries.

With effect from financial year 2007-08, the Government has included allotment of shares to employees under Employee Stock Option Plans (ESOPs), within the ambit of FBT. To provide clarity on the applicability of ESOPs, the Government issued another circular in December 2007.

FBT collections have increased by 64.79 per cent to Rs 5,121 crore till January 15, 2008, in the current fiscal year against Rs 3,108 crore during the same period last fiscal.

“The industry associations have sought withdrawal of FBT regulations altogether. Considering the significant contribution of this levy to the exchequer, it is unlikely that the Government will heed to this request,” says Rajesh S., Director.

“There are high expectations that the Government may withdraw ESOPs from the FBT levy to provide some relief to IT and other export-oriented companies after considering the impact of a) rupee appreciation, b) the sub-prime crisis and potential economic recession in the US; and c) the inflating cost structure in technology and other export-oriented industries.”

According to Rajesh, such a measure will also indirectly benefit the employees of the companies as the FBT costs are recovered from them in most situations.

MAT and technology industry

The Indian tax law provides for Minimum Alternate Tax (MAT) to be paid by companies on the basis of profits disclosed in the financial statements. Companies must pay 10 per cent (plus applicable surcharge and cess) of book profits as tax, if the tax payable as per regular tax provisions is less than 10 per cent of its book profits. Book profits for this purpose are computed by making prescribed adjustments to the net profit disclosed by the companies in their financial statements.

Finance Act, 2007 has extended the applicability of MAT to companies enjoying tax holiday under Section 10A/10B of the Income-Tax Act, 1961. Typically these entities are those that have set up units under the Software Technology Parks (STP) scheme or Export Oriented Units (EOUs), which currently enjoy a tax holiday till March 2009.

MAT paid in excess of the normal tax payable by a company for a particular year can be carried forward as credit to be offset against future income tax payable under the normal provisions of Act. The carry forward of such MAT credit is at present restricted to seven years following the year in which the credit arises.

“With a strengthening rupee and a global slowdown, the software and services export industry is facing pressure on margins, further aggravated by increasing costs. The impact will be more on the SME segment,” says Jayesh Sanghvi, Patner. “It is thus expected that the tax holiday benefit will be extended beyond 2009. It remains to be seen whether the same would be made co-terminus with the SEZ benefits that extend for 15 years.”

According to Sanghvi, While MAT on all companies can be justified based on horizontal equity, the present STP/EOUs should also be spared from the impact of MAT to ensure a level-playing field with SEZ units. At the least MAT rate should be reduced to the previous rate of 7.5 per cent.

Stamp Duty and real estate sector

The growth story thus far in Indian real estate has been told despite the impediment of high stamp duty rates, which have thwarted the creation of a sound and robust secondary property market. Stamp duty levies abound in the double digits in some States (not to mention stark differences in the scope of the levy and applicable rates across India), in sharp contrast with the rates in developed markets such as Singapore and Europe, where the levies are typically between 1-3 per cent.

Incidence of duty at multiple stages on the same property (firstly on acquisition of land and subsequently, on the sale of developed units or lease of property) add to property prices and rentals, which are already stretching beyond the purchasing power of the larger masses.

Court schemes, such as amalgamations and demergers, and holding company to subsidiary company transfers are now taxed in several States, annulling even the limited exemptions that were possible earlier under stamp law.

The current scenario is, therefore, quite discouraging, from the perspective of the stamp duty levy. The next target of this transaction cost shall be REITs, which may fail ab initio, if exemptions from this levy are not granted.

“How much the Budget can do to provide relief from stamp duty is questionable, given the empowerment the States have under the Constitution on this subject. What will help though are initiatives from the Centre to build consensus among States on lowering/rationalisation of stamp duty rates, credit mechanisms and exemptions for REITs,” says Ajit Krishnan, Tax Partner.

“The experience on VAT should help in ‘actioning’ these and some of the recommendations of the National Housing and Habitat policy, which have been gathering dust so far. Only then will the creative but risky structures and cash dealings, now typical of the sector, be eliminated.

Courtesy - sify