By Ashish Mehta, Partner, and Sanket Shah, Principal Associate, Khaitan & Co., Mumbai
The Indian tax administration on 10 August issued rules for computing relief related to the tax on book profits in cases where there was an increase in book profits of a particular financial year on account of an advance pricing agreement (APA) or a secondary adjustment of previous years.
Book profits tax and APAs / secondary adjustments
Under Indian income tax law, certain companies are liable to pay taxes based on book profits in an amount equal to 15% (plus applicable surcharge and cess) of their adjusted book profits or tax computed as per normal provisions of the Income-tax Act, 1961, whichever is higher.
Advanced pricing agreements and secondary adjustments were introduced in the Indian tax law in 2012 and 2017, respectively. Owing to the time gap between filing of tax returns and their assessments by tax authorities, as well as time lag between application for and entering into an advance pricing agreement with the authorities, it is possible that book profit of a later year increases on account of incomes of past year(s). This is so because from an accounting perspective, adjustments on account of transfer pricing provisions would be reflected in the book profit of the financial year in which such adjustments were made or advance pricing agreement is entered. Thus, there would arise a situation where the taxpayers would need to pay higher book profits based taxes.
To address this situation, an amendment was introduced in February 2021 to provide a mechanism for the taxpayer to approach the tax administration for re-computation of the book profit of the previous financial years and the tax payable in the subsequent financial year to reflect changes on account of an advance pricing agreement, a secondary adjustment, etc., pertaining to the previous financial years.
The current notification implements the amendments (Section 115JB(2D) and Rule 10RB) providing for tax relief.
Computation of tax relief
The rule provides that the tax payable in the current financial year shall be reduced by an amount calculated using the formula: (A – B) – (D – C).
In this formula, “A” equals the tax payable by the company on its adjusted book profits of the current financial year, including the past incomes which are included in the current year’s book profits on account of adjustments due to an advanced pricing agreement or secondary adjustments.
“B” is the tax payable by the company on its adjusted book profits of the current financial year after reducing from the book profits past incomes which are included on account of adjustments due to advanced pricing agreements or secondary adjustments.
“C” equals the aggregate of tax payable by the company on its adjusted book profit of those past year or years to which the past income belongs.
Finally, “D” is the aggregate of tax payable by the company on its adjusted book profit of the past year or years (referred to in item “C”) after increasing the book profit with the relevant past income of such year or years.
If the formulae result in a negative number, the adjustment value will be nil.
Further, the rules provide certain specifications regarding amounts A–D.
The value of amount “A” in the formula would be zero if there is no tax payable on the adjusted book profits of the current financial year, including the past years’ income.
The value of amount “B” in the formula would be zero if there is no tax payable on the book profits of the current financial year after reducing from the book profit with the past years’ income.
For calculation of amount “C” in the formula, if in any past year(s) there is no tax payable on adjusted book profits of that year(s), the tax payable for that year(s) shall be deemed to be zero.
For calculation of amount “D” in the formula, if in any past year(s) there is no tax payable on adjusted book profits of that year(s) after increasing the book profit with the relevant past incomes of such year(s), the tax payable for that year(s) shall be deemed to be zero.
Under the Indian tax laws, the tax paid on book profits is allowed to be carried forward for 15 financial years to be set off against the tax payable under the normal provisions. The notified rules provide that the company’s tax credit will be reduced by the amount of tax relief computed and allowed under these rules.
Claim of tax relief
As part of rules, the Central Board of Direct Taxes has announced the form (Form No. 3CEEA, to be filed electronically) for a company to claim this tax relief.
Conclusion
Under the Income-tax Act, tax on book profits does not apply to companies that forgo certain exemptions and opt for the concessional tax rate. However, these rules provide the much-needed relief for companies that have entered into advance pricing agreements and/or have suffered secondary adjustments and have not opted for the concessional rate of tax.
Further, it is also pertinent to note that the provisions as applicable to rectification applications have been made applicable to such applications seeking tax relief, and accordingly the authorities are expected to decide these applications within six months. Hopefully these applications will be processed promptly to enable companies to compute and pay appropriate taxes in time.
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