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Income Tax - Section 115BAC lurches towards Neutrality in Taxation

FEBRUARY 9, 2023

By J B Mohapatra

SPECIAL rates of tax, exemptions, deductions, rebates, deferrals and credits in line with the stated policy of the government, earlier a part of the budget document under "Statement of Revenue Foregone" and since budget 2018-19 appearing under Annexure 7 of the Receipt Budget under "Statement of Revenue Impact of Tax Incentives Under Central Tax System" and commonly known as tax expenditure are necessary policy instruments for directing investment and expenditure out-flows towards sectors and segments deemed necessary in the context of socio-economic imperatives of the day. Year-wise tax expenditure since 2018-19 as per budget documents are:

Status of ITR Filers

Tax Expenditure 2018-19

Tax Expenditure 2019-20

Tax Expenditure 2020-21


Rs 1,08,113 cr (8,85,289 Companies)

Rs 94,109 cr (9,17,494 Companies)

Rs 75,218 cr (9,61,279 Companies)

A.O.P, B.OI and Firms

Rs 6,804 cr (15,45,987 firms etc)

Rs 8,043 cr (15,79,898 firms etc)

Rs 7,731 cr (16,22,196 firms etc)

Individuals and HUF

Rs 95,376 cr (6,53,88,044 numbers)

Rs 1,55,429 cr (6,30,85,608 numbers)

Rs 1,28,244 cr (6,38,09,874 numbers)

That said, the two canonical underpinning of a progressive tax system - broader base and lower rate - has incessantly engaged policy makers to explore and establish through revenue neutral tax reforms a system where tax, tax rate and tax incentives in an interplay with each other do not adversely impact and distort market and individual choices.

Consequently we saw enactment of section 115BA in Finance Act 2016 with effect from 1-4-17 for companies registered before 1-4-16 and section 115BAA in Taxation Laws Amendment Act 2019 with effect from 1-4-20 rendering a choice to domestic manufacturing companies for taxation at @25% or 22% provided (a) they forego their claims under section 10AA, 32(1)(iia), 32AD, 33AB, 33ABA,35(1)(ii)/(iia)/(iii)/(2AA)/(2AB), 35AD, 35CCC, 35CCD, and all deductions under chapter VIA barring those under section 80JJAA (b) agreeing not to claim set off of past losses and unabsorbed depreciation. Through Finance Act No 2 of 2019, another option was made available through section 115BAB to new manufacturing companies set up and registered on or after 1-10-19 and commencing production or manufacturing of an article or thing on or before 31-3-23 ( since extended to 31-3-24) to get themselves taxed @15% provided they forego such claims of deduction and exemption listed therein similar to section 115BAA. Both sections 115BA and 115BAA are optional and voluntary and would have attracted those companies who saw immediate and future advantages in opting into these provisions. A total of 1,96,758 companies or 20.47% of the total number of companies who have filed their ITR and 3,508 new manufacturing companies as per details in the Receipt Budget for 2023 have opted for the choices given in section 115BAA and section 115BAB respectively.

In respect of resident cooperative societies in like manner, section 115BAD introduced through Finance Act 2020 delineated a concessional tax regime @22% provided they forego certain deductions and exemptions. Finance Act 2023 has taken forward this concept of concessional tax regime for resident cooperative societies set up and registered after 1-4-23 and commencing manufacturing and production before 31-3-24 through introduction of section 115BAE.

While it is undeniable that the universe of individuals and HUF remain the largest among all ITR filers, it was 4 years after the concessional tax regimes through Finance Act 2016 was extended to companies through section 115BA, that one saw a similar legislative attempt for individuals and HUF through enactment of section 115BAC through Finance Act 2020 with effect from 1-4-21. Much in the manner of the strategy outlined for companies and resident cooperative societies, the concessional tax regime for individuals and HUF was premised on the taxable entity foregoing its claims under section 10(5)[ travel concession allowance], 10(13A)[rent allowance for residential accommodation], 10(14)[special allowance granted to meet performance of duties of an office], 10(17)[daily allowance and contingency allowance to members of parliament or state legislature], 10(32)[ exemption in respect of clubbing of income under section 64], 10AA[exemption for newly established units in SEZ], 16[standard deduction, entertainment allowance and tax on employment], 24(b)[ interest on borrowed capital for self -occupied property], 32(1)(iia)[ additional depreciation], 32AD[ additional depreciation for investment in notified backward areas], 33AB[ special allowance under tea development, coffee development and rubber development account], 35(1)(ii)/(iia)(iii)/(2AA)/(2AB)[ weighted deduction for research and development], 35AD[capital expenditure of specified business], 35CCC[ expenditure on agricultural extension project], 57(iia)[ deduction from family pension], all claims of deduction under chapter VIA other than section 80CCD[ contribution to pension scheme of the central government], and 80JJAA[ deduction in respect of new employees]. There would be furthermore no claim for set off of carried forward loss or unabsorbed depreciation. In case an option is exercised in favour of the concessional regime under section 115BAC(5) and conditions under subsection (2) are satisfied, then the entity is liable to be taxed as follows: Nil up to Rs 2.50 lakhs, 5% for total income from Rs 2.50 lakhs to Rs 5 lakhs, 10% for total income from Rs 5 lakhs to Rs 7.5 lakhs, 15% for income from Rs 7.50 lakhs to Rs 10 lakhs, 20% for income from Rs 10 lakhs to Rs 12.50 lakhs, 25% for total income from Rs 12.50 lakhs to Rs 15 lakhs and at 30% for total income in excess of Rs 15 lakhs.

Furthering the possibilities of larger coverage of likely entities into the concessional tax regime, additional incentives and structural modification to the working of section 115BAC as per clause 50 of the Finance Bill 2023 now include, apart from rearranging the taxable slabs, the following: (a) in addition to individuals and HUF, the new regime now includes AOP,BOI and artificial juridical persons (b) with effect from 1-4-23, the entity can additionally claim deduction of own and government contribution to the Agniveer corpus fund (c) rebate from tax in respect of total income up to Rs 7 lakhs (tax up to Rs 25,000) (c) standard deduction of Rs 50,000 under section 16(ia) and deduction from family pension under section 57(iia) can be claimed while determining total income under section 115BAC (d) in spite of removal of options clause in section 115BAC(5) with effect from 1-4-24, with the insertion of sub-clause (6), the choice of exercising the option still vests with the taxable entity.

Though the tax arbitrage opportunities vis a vis the old dispensation remain the most persuasive catalyst for moving to the new regime, it is undeniable that approximately 92% of the 3 cr ITR 1 filers, 83% of 50 lakhs ITR 2 filers, 90% of 1.20 cr ITR 3 filers, and 99% of 1.75 cr of ITR 4 filers comprising the sub-Rs 10 lakhs of gross total income and who may not have full and exhaustive claims of deductions and exemptions would find in the context of additional benefits through Finance Bill 2023, sufficient economic merit for opting in to the newer taxation regime.

Idea that drives the provisions of section 115BAA, 115BAB, 115BAC, and section 115BAE is 'tax neutrality', a concept that explicitly conveys that an individual's decisions on where and how much to spend or invest should not be mired with considerations other than economic merits subject to the onerous responsibility on the policy makers and legislation to target and promote certain time relevant national policy goals. Exemptions, deductions, deferrals, credits, special allowances and rates are generally instruments of a non-neutral tax system, where choice are driven more by tax consideration and less by economic merits. It also follows that a non-neutral tax system would not be leading to the most productive use of economic resources and ultimately hobble economic efficiency in the long run apart from introducing complexities and distortion in tax legislation and increased compliance costs. Joseph Stiglitz in "Tax Reform: Theory and Practice" (Chapter 2 of The Economics of Tax Reform, 1988) has conveyed the imperatives of a reconciliation needed for a neutral tax system and dangers of overloading the tax system with narrow policy objectives which should never have been configured within the tax legislation. In his words, the following:

"First, it appears to me that we have asked too much of ourtax system. By asking more, we may have gotten less. We havebeen overly ambitious in our attempts to redistribute income through the tax system, and as a result, we have provided incentives for massive tax avoidance. We have attempted to address the energy crisis and other social ills with our tax system; from an administrative perspective, this may not be unreasonable. It may be cheaper, for example, to subsidize the rehabilitation of our inner cities through the tax system than to set up a grants program. But the overall loss in faith in the equity of our system of financing public services may not be worth the savings in administrative costs."

In India there have been consistent attempts to clean up the tax legislation of the myriad forms of deductions and exemptions mostly on a belief that they are non-neutral, distort market and individual choices, and ultimately lead to erosion of tax base. Remodelled section 115BAC must be seen as continuation of those attempts at achieving neutrality, minimise economic distortion and promote economic efficiency.