The union budget is keenly watched as a statement on the health of the economy, the direction for the year ahead in terms of policy announcements and—very important—for the changes to the tax regime. Over time, the changes to indirect taxes have become less relevant as these are dealt with by the GST Council. But amendments to direct taxes become very relevant.
From the finance minister’s speech, the Finance Bill, 2022, seems to be relatively benign with not too many tax proposals. But on reading the fine print, we find many changes, some of considerable significance. Before I deal with some of the key ones and what they portend for us, let me compliment the FM for the direction of the Union Budget with respect to spending on infrastructure and revival of the capital spend cycle. These are the need of the hour and if implemented as budgeted, should help spur the economy and provide an impetus to employment generation. Let me now deal with a few of the important tax proposals.
The first and the most important change is the revival of the trend of retrospective amendments, something we have been repeatedly assured this government will not resort to. There is one specific retrospective amendment (not allowing deduction of Health and Education Cess w.e.f. AY 2005-06). Leaving aside the merits of the matter (this cess is not tax; it is meant to promote education and not credited to the Consolidated Fund of India), this tendency of retrospective amendments to overturn judicial decisions is best curbed. Once it starts, we will see this as an ongoing process which will impact our credibility. Then there are two other amendments, made with effect from Assessment Year 2022-23 (this, again, is a new trend to make amendments effective from the beginning of the year and make it retrospective by a year), but made as clarificatory amendments to provide that the law always meant what the amendment now says!
The two changes are with regard to deductibility of interest under Section 14A where there is no tax-free income and deductibility under Section 37 of payments made for violation of overseas laws, for compounding of offences, and to people who are receiving it against the law, regulations or policies applicable to them. This is expected to particularly impact payments made or expenditure incurred by pharma companies to doctors. Such payments have been held as tax deductible by several courts and now the law is proposed to “clarify” that it always meant that such payments are not tax deductible.
This back-door attempt at retrospective amendment (making it prospective but drafting it as a clarificatory amendment) may not pass the muster of courts for the past years. The government is well within its rights to provide what is tax deductible prospectively but not try to clarify a law already interpreted by the courts. On merits, the amendment to Section 37 may lead to controversies with regard to payment of Compounding Fees where no offence is admitted, deductibility of payments overseas for settlement of disputes for infringement of IP rights purely to avoid long-drawn litigation, etc.
The next change of concern is the amendment to Section 68, which deals with unexplained credits. The law, as it stands today, requires a borrower to demonstrate the genuineness and capability of the lender. The proposed amendment requires the borrower to prove to the satisfaction of the Assessing Officer the nature and the source of the funds of the lender. No exceptions are carved out. So, a bank needs to demonstrate the source of funds of the depositors, a borrower from a bank or a financial institution needs to demonstrate the source of funds from where such bank or institution got the funds, and the situation would get worse for borrowings from private sources. It is indeed unfortunate that we legislate to address some bad apples and the impact is on genuine taxpayers who will struggle with faceless assessments to prove what they cannot. Just imagine the impact of this provision considering the fact that an addition under this Section gets taxed at 60 per cent plus interest, plus penalty. There is certainly no merit to casting the burden of proving source of funds on the borrower, particularly when the tax details of the lender are filed and the tax office can reach the lender.
The next set of provisions relates to reopening of tax assessments under Section 148 of the Act. Until the last Budget, tax assessments could be reopened for six years unless overseas assets were involved. This was truncated to three years generally and 10 years in exceptional cases. While the reduction to three years was welcomed generally, it was feared that the exceptional 10 years will become the norm. Those fears seem to be coming true. It is now sought to be provided that tax assessments can be reopened on account of audit objections and to take into account expenditure and book entries. This will result in finality of tax assessments going away and the threat of reopening up to 10 years becoming real.
The taxation of digital assets has invoked a great deal of debate and has raised a question as to whether the taxation of these assets legitimises them. Suffice to say that it recognises them but does not legitimise them. The approach of the government is to provide for taxation of these assets as a separate block taxable on a gross basis at the rate of 30 per cent without deduction of expenses and set off or carry forward of losses. There seems to be no reason to deny expenses incurred. That apart, the way the provisions are worded, they lend themselves to an interpretation that losses from one type of digital assets cannot be set off against gains from another type. That certainly does not seem to be the intention and an appropriate drafting would help. Also, there is a need for clarity on the head of taxation under which these gains would be taxable.
To summarise, overall the Budget provisions are welcome.The government just needs to iron out a few issues, including the fear of the amendments being applied retrospectively, in order to avoid any unintended litigation and provide certainty to taxpayers, which is sought to be the hallmark of the tax reforms made over the years.
The writer is CEO of Dhruva Advisors LLP. Views are personal
