Holding companies & HNIs can lower tax with higher deductions
March, 04th 2016
Many holding companies of business groups, corporates and MNCs with subsidiaries, and even individuals investing in stocks are awaiting a new 'rule' that would allow them to lower tax outgo. The finance minister, in his Budget speech, has announced a change in a specific rule which, according to tax professionals, would allow higher deductions and lower taxable income. According to tax laws, if an assessee earns income that is not chargeable to tax, then the corresponding expenditure for earning such exempt income is not permitted as deduction.
Thus, an investment holding company or a corporate receiving dividend income — which is not taxed in the hands of the receiver — cannot deduct the interest cost on borrowings and administrative expenses to reduce tax burden.
But since many equity investments do not generate dividend, companies have been insisting that costs on borrowing and administration should be allowed as deduction. The Income-tax department has been denying this on the grounds that such investments, though not yielding any dividend today, are capable of earning dividend in future. The difference in opinion has led to several disputes between companies and the tax office.
In fact, tax professionals said about 20% of the corporate litigation is about disallowance under section 14A — the related Section in the Incometax law — due to differences in interpretation.
Consider this. A company borrows Rs 10 crore at the rate of 10% to invest in four stocks — worth Rs 2.5 crore invested in each; of the four stocks, only one generates dividend income of say, Rs 1 lakh. The company has an administrative expense of Rs 5 lakh and its 'other income' from interest, royalty, and capital gains, is Rs 5 crore. The company believes that its total taxable income isRs 3.95 crore, which is other income of Rs 5 crore net of interest cost and administrative expense ofRs 10,500,000. But based on the total assets of the company (say, Rs 12 crore here), the tax department claims tax on an additional income of Rs 85 lakh.
Thus, to the taxman, the company's total taxable income is Rs 4.75 crore, and not Rs 3.85 crore as offered by the company. The formula used by the tax officer to arrive at the taxable income is based on the total interest cost, investment in shares earning tax-exempt income, and total assets of a company. The finance minister has proposed that the particular rule (Rule 8D) will be amended and disallowance of deductions will be limited to 1% of the average value of monthly investments yielding exempt income. In the above example, this investment is valued at Rs 2.5 crore (because only one out of four stocks is generating dividend income).
"Almost every holding company which has invested in subsidiaries are facing disallowance under section 14A of the I-T Act — which means they cannot treat the interest on borrowed money and some of the other expenses as deductible. Now, these expenses will be allowed as deductions even if the investments are not earning any dividend. Holding companies such as Tata Sons is expected to have a substantial gain," said senior chartered accountant Dilip Lakhani.
As per the Budget announcement, starting next year the tax department can make an addition of only Rs 2.5 lakh (i.e, 1% of Rs 2.5 crore) — not Rs 85 lakh as it would have otherwise done. Thus, the taxable income of the company would be Rs 39,750,000, which is only Rs 2.5 lakh higher than the amount ofRs 3.95 crore that the company had offered to tax.