India

Corporate - Income determination

Last reviewed - 14 May 2020

Income computation and disclosure standards (ICDS)

The CBDT has notified ten ICDS to be followed by all taxpayers that follow the mercantile system of accounting for the purpose of computation of income chargeable to income tax under the head ‘profits and gains of business or profession’ or ‘income from other sources’ and not for the purpose of maintenance of books of accounts. In case of conflict between the provisions of the Income-tax Act and the ICDS, the provisions of the Income-tax Act shall prevail to that extent. These standards have been implemented from tax year 2016/17.

The list of certain important points on implementation of ICDS is given below:

  • Inventory has to be valued at lower of cost or net realisable value. Further, cost of inventory is to include taxes paid, irrespective of recoverable or not.
  • Interest on compensation or enhanced compensation is to be offered to tax in the year of receipt.
  • Any subsidy or grant received from the government that is not adjusted to cost of asset shall be offered to tax in year of receipt of such subsidy/grant even if the conditions attached to it are not yet fulfilled.
  • Marked-to-market loss computed in accordance with ICDS shall only be allowed.
  • Gain/loss on account of foreign currency fluctuation for monetary and non-monetary items shall be computed and allowed as per provisions of ICDS.
  • Profits from construction contracts and/or service contracts shall be calculated based on the percentage of completion method. For service contracts with less than a 90-days period, the project completion method can be used. Further, for service contracts with an indeterminate number of acts over a specific period of time, the straight-line method can be used. Retention money shall be included while computing contract revenue.
  • It may be noted that ICDS does not recognise the concept of materiality and the concept of prudence.

Inventory valuation

Inventories are generally valued at cost or net realisable value, whichever is lower. Generally, there is conformity between book and tax reporting. The first in first out (FIFO) and weighted average cost methods are acceptable, provided that they are consistently applied.

Capital gains

Capital gains refer to the gains made on the transfer of a capital asset. Transfer includes sale, exchange, relinquishment, or extinguishment of rights in an asset. Capital assets are either short-term capital assets or long-term capital assets. Long-term capital gains are eligible for a concessional rate of tax and indexation of cost of purchase and cost of improvement (discussed below).

Short-term capital assets are capital assets held for a period of not more than 36 months. In case of listed shares, listed securities, or units of specified mutual funds or zero-coupon bonds, the short-term holding period is not more than 12 months, and in case of unlisted shares is not more than 24 months. Capital assets that do not qualify as short-term capital assets are considered as long-term capital assets.

Normally, long-term capital gains are determined after increasing the cost by a prescribed multiplier that varies with the period of holding, to adjust for inflation. In case of non-residents, capital gains on transfer of shares or debentures in Indian companies are computed in the foreign currency in which the shares or debentures were acquired, and the capital gains are then reconverted into Indian currency to compute the tax liability thereon.

Capital gains are taxed as follows:

  • Long-term capital gains on the transfer of equity shares in a company acquired on or after 1 October 2004 shall be exempted only if STT was paid at the time of acquisition. This exemption stands withdrawn from 1 April 2018. Post such withdrawal, the long-term capital gains exceeding INR 100,000 will be taxed at the rate of 10% (plus surcharge and health and education cess). The said amendment will be applicable to units of equity oriented funds as well. The benefit of adjustment of cost of inflation index will not be available. In addition, the benefit of computation of long-term capital gains in foreign currency in the case of a non-resident will not be allowed.
  • Other long-term capital gains are subject to taxation at 20% (plus the surcharge and health and education cess). However, long-term capital gains arising from the transfer of listed securities, units, or zero-coupon bonds on which STT is not paid are taxed at 10% (without adjusting the cost for inflation) or at 20% (after adjusting the cost for inflation), whichever is more beneficial to the taxpayer. These rates exclude surcharge and health and education cess.
  • Long-term capital gains arising to a non-resident (not being a company) or a foreign company from transfer of unlisted securities, shares, debentures, etc. are taxable at 10% (plus surcharge and health and education cess) without any indexation benefit.
  • Short-term capital gains on the transfer of listed shares in a company or units of an equity-oriented fund that are subject to STT are taxed at 15% (plus surcharge and health and education cess).
  • Other short-term capital gains are subject to taxation at the normal rates.
  • In the case of certain overseas financial organisations (e.g. off-shore funds and foreign institutional investors), long-term capital gains arising on the transfer of units purchased in foreign currency are taxable at 10% (plus surcharge and health and education cess) on the gross amount.
  • Transfer of rupee-denominated bonds (issued by an Indian company outside India) held by a non-resident to another non-resident will be exempt from long-term capital gains. Further, the benefit of excluding the forex appreciation of rupee-denominated bonds in the capital gains computation at the time of redemption will also be extended to secondary holders of such bonds. This is effective from tax year 2018/19 onwards.
  • The indexation benefit is available on cost of acquisition and cost of improvement for assets classified as long-term while computing capital gains. The taxpayer shall have the option to consider the fair market value of the asset on 1 April 2001 as the cost of acquisition where date of acquisition is before 1 April 2001. This is effective from the tax year 2018/19.

The rules of carryforward and set-off of loss for capital gains are as follows:

  • Capital losses arising from the transfer of a short-term capital asset can be set off against capital gains arising from any other asset in the same tax year.
  • Capital losses arising from the transfer of a long-term capital asset can be set off only against capital gains arising from the transfer of any other long-term capital asset.
  • Capital losses that cannot be set off in the tax year in which they are incurred can be carried forward and set off against future capital gains at any time within a period of eight years after the year of loss.
  • When depreciable assets forming part of a block of assets for tax purposes are transferred, as a result of which the value of the block becomes negative, or all the assets forming part of the block cease to exist, the difference between the transfer price and the value of the block is treated as short-term capital gain or loss.

Taxability of shares issued at a price less than fair market value of shares

Where a closely held unlisted company receives any consideration from a resident towards issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value will be deemed to be the income of the recipient-company. The 'fair market value' is computed according to the formulas per the prescribed mechanism. Further, the said provision has been amended and, accordingly, the scope has been widened. From tax year 2018/19, entities are liable to pay taxes on the following receipt that they have received without consideration or for a consideration that is less than the fair market value:

  • Any sum of money.
  • Any immovable property being land or building, or both.
  • Any property, other than immovable property, being shares and securities, jewellery, archaeological collections, drawings, paintings, sculptures, any work of art, and bullion.

Taxability of transfer of property for nil or inadequate consideration

Where a person is in receipt of the following property for nil consideration or for an inadequate consideration, then the difference between the fair value of the property and the consideration paid shall be considered as deemed income in the hands of recipient of the property:

  • Any sum of money.
  • Any immovable property being land or building, or both.
  • Any property, other than immovable property, being shares and securities, jewellery, archaeological collections, drawings, paintings, sculptures, any work of art, and bullion.

In a case where the difference between the fair value of property and consideration paid does not exceed INR 50,000, the same shall be ignored from this taxation. However, the Finance Act, 2018, has liberalised the limit of INR 50,000 in case of immovable property. It is now provided that no adjustments shall be made in a case where the variation between stamp duty value and the sale consideration is not more than 5% of the sale consideration.

Dividend income

Dividend income received by a domestic company with effect from 1 April 2020 shall be taxable in hands of resident shareholders at the rates applicable to them. Further, in case of non-resident shareholders, dividends received post 1 April 2020 may be taxed at the rate of 20% under the Income-tax Act or tax treaty rate, whichever is beneficial.

WHT obligations shall arise in the hands of a company distributing dividends to non-resident shareholders in such case. A corresponding deduction on account of interest would be allowed to the extent of 20% of such dividend income. This change is brought considering that DDT has been abolished with effect from 1 April 2020.

Dividend income received from a foreign company or business trust will be considered, in addition to dividend income received from a domestic company, for removal of the cascading effect of tax on dividend income, if any.

Stock dividends (bonus shares) distributed are not taxed at the time of receipt in the hands of the recipient shareholders, but capital gains provisions are applicable to the sale of these stock dividends.

Buyback of shares

An additional tax is payable on transactions involving buyback of shares by Indian companies from its shareholders. A tax at 20% (plus surcharge at 12% and health and education cess at 4%) is payable by the company on the difference of consideration paid on buyback and the issue price of shares. The CBDT has prescribed the methodology for determination of amount received for issue of shares under 12 different situations, being a subject matter of tax on buyback. The buyback consideration received will be tax exempt in the hands of the receiver. No tax credit will be allowed in case of such taxes paid either to the company or to the shareholder.

Interest income

Interest income received by an Indian company is taxable at normal CIT rates. Interest income received by a foreign company is taxed at a concessional rate of withholding at 5%/20%, subject to conditions.

Royalty income

The domestic tax law defines the term ‘royalty’ to include consideration from the transfer of all or any rights (including the granting of a licence), imparting of any information, or use or right to use of any right in respect of a patent, invention, model, design, secret formula or process, trademark, or similar property. The definition also includes imparting of any information concerning technical, industrial, commercial, or scientific knowledge, experience, or skill; use or right to use any industrial, commercial, or scientific equipment; the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic, or scientific work, including films or video tapes for use in connection with television, or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution, or exhibition of cinematographic films; or rendering of any services in connection thereto. Further, the Finance Act, 2020 has brought an amendment to include consideration for sale or distribution or exhibition from cinematographic films in ambit of definition of royalty.

Royalty income received by a non-resident taxpayer is taxed at 10%, 15%, or 20% (subject to treaty benefits and furnishing of prescribed documentation). Surcharge and health and education cess, as applicable, will be levied in addition to the basic tax rates mentioned above. However, surcharge and health and education cess would not apply on the tax rate specified in the tax treaties. The issue is litigative, and there are divergent views on this.

Further, income arising to a non-resident/foreign company by way of royalty/FTS rendered in/outside India to a national technical research organisation shall be exempted.

Partnership/LLP income

A partnership firm and an LLP are taxed as separate legal entities. The share of income of partners from a partnership firm or an LLP is exempt from tax. Partnerships and LLPs are taxed at 31.2% (inclusive of surcharge and health and education cess) if the income is less than INR 10 million and 34.944% (inclusive of surcharge and health and education cess) if the income exceeds INR 10 million. Alternate minimum tax at the rate of 18.5% applies to a partnership/LLP.

The interest payment to partners on capital or current account is allowed as tax-deductible expenditure. However, the maximum interest rate allowable for tax purposes is 12% per annum. A working partner can be paid salary, bonus, commission, or remuneration. The maximum permissible deduction in respect of remuneration payable collectively to all working partners is based on the book profit of the firm, at slab rates for different levels of book profit.

Unrealised exchange gains/losses

General principles for classification of foreign exchange gains or losses are as follows:

  • Unrealised foreign exchange profit/loss is considered to be of a capital nature if a foreign currency loan is taken for a capital asset or fixed asset purchased outside India.
  • Any other unrealised foreign exchange profit/loss (not covered above) is considered as revenue in nature.

Foreign income

An Indian company is taxed on its worldwide income. A foreign company is taxed only on income that is received in India, or that accrues or arises, or is deemed to accrue or arise, in India. This income is subject to any favourable tax treaty provisions. According to the current tax law, payments for allowing/transferring the right to use software, customised data, or transmission of any signal by satellite, cable, optic fibre, or similar technology are taxable as royalty income deemed to accrue or arise in India, whether or not the location of such right or property is in India. The CBDT has notified the rules for granting foreign tax credit to resident taxpayers in respect of taxes paid in overseas countries. The rules lay down broad principles and conditions for computation and claim of foreign tax credit, respectively. In cases where the taxpayer has not been given credit of certain taxes paid outside India since the tax was under dispute, the taxpayer can approach the tax officer within six months from the end of the month in which the dispute was settled with prescribed documents. The tax officer has been empowered to pass an order granting consequential relief. This has been made effective from tax year 2018/19 onwards.

Double taxation of foreign income for residents is avoided through treaties that generally provide for the deduction of the lower of foreign tax or Indian tax on the doubly taxed income from tax payable in India. Similar relief is allowed unilaterally where no tax treaty exists, in which case a resident would be taxed under the Indian tax law but would be allowed a deduction from the Indian income tax payable of a sum being the lower of the Indian tax rate on the doubly taxed income or the rate of tax prevailing in the other country in which income is already taxed.