Report No. 12
Provisions Against Avoidance of Tax
Notes to clause 95
Sub-section (2) of section 42 has been redrafted with a view to bringing out what was really intended. The object is to catch the income of the resident where a business is carried on between a resident and a non-resident and the profits of such business are camouflaged in such, a way that the resident receives either no profits or less than normal profits. In such a case the Income-tax Officer has to determine the true profits of the resident attributable to such camouflaged transactions. This is now brought out clearly in the draft.
The existing section says that the income of the non-resident shall be chargeable "in the name of the resident who shall be deemed to be the assessee". These words have been replaced in the draft by the words "and include such amount in the total income of the resident". This verbal change has been made for the sake of uniformity, and for emphasising the true construction of the section as explained above.
Notes to clause 96
The existing section 44D relating to transfer of assets to non-residents is considerably involved in its expression. It is difficult to understand the section as a whole and its or grammatical structure without some effort. The section has been slightly recast on the lines of section 412 of the U.K. Act.2 The important points of difference between the existing section and the draft clause are explained below:-
1. For a criticism of section 412 of the U.K. Act corresponding to section 44D of our Act, see p. 311, para. 1029(5) of Report of the Royal Commission on the Taxation of Profits and Income (Final Report).
2. U.K. Income-tax Act. 1952. Cf. U.K. Finance Act, 1936, section 18.
(1) Sub-sections (1) and (2) of the existing section 44D repeat the words "transfer of assets by virtue or in consequence whereof, either alone or in conjunction with associated operations, any income becomes payable" etc. This condition precedent has been transferred in the draft clause to the opening lines, thus saving the repetition appearing in existing sub-section (2).
(2) The existing section 44D(1) says that a transfer of assets must be one whereby "any income which, if it were the income of such person, would be chargeable to income-tax" becomes payable to a non-resident. This requirement of potential chargeability is thus applicable to the income arising from, the transfer. In the draft, however, it has been removed from that place and shifted to the income over which the resident has power to enjoy [See draft sub-clause (1)(a)]. This change is in harmony with the more important change discussed below under item (5).
(3) In existing section 44D(1), the reference to associated operations occurs only in the beginning of the section, that is, the portion referring to transfer whereby certain income arises. This reference is not repeated in the subsequent portion dealing with acquisition of rights by the transfer. In other words, the rights giving the power to enjoy certain income must, at present, flow from the transfer itself. Under the clause as drafted, however, these rights might flow either from the transfer or from its associated operations.
(4) The words "in consequence of which" occurring for the second time in the existing section 44D(1) have been omitted in the draft. These words related to "rights in consequence of which he has power to enjoy". It seems sufficient to have the words "by virtue of in this context.
(5) Under the existing section 44D(1), the income to be taxed as the income of the resident is "that income", that is, the income earlier referred to as arising from the transfer to a non-resident, which the resident has power to enjoy. Thus, two ingredients are required for taxing the income at present: (i) the income must arise from the transfer, and (ii) it must be income which the resident has power to enjoy. The draft clause, however, makes an important departure here. All that is required in order to tax an income is that (other conditions being satisfied), it must be income which the resident has power to enjoy. Under the draft it is not necessary that the taxable income should coincide with the income arising to a non-resident from the transfer. Thus the power to enjoy must: arise from the transfer, but the words "power to enjoy such income" have been replaced by "any income of a non-resident".
(6) The existing section 44D(2) suffers from one important flaw, in that it does not state how the sum referred to therein is to arise The section says: "Where any person receives or is entitled to receive any sum paid by way of loan etc such income shall be deemed to be the income" of the resident. One would have expected the section to say, like sub-section (1), "when any person by means of any transfer receives any sum etc. The draft sub-clause (1)(b) makes it clear that the capital sum must be one "the payment whereof is in any way connected with the transfer".
This is merely a condition to be satisfied. What is to be charged to tax is a different matter, discussed in the next item.
(7) The existing section 44D(2) says that "such income shall be deemed to be the income" of the resident. It is with some effort that one is able to locate the income to which this word "such" is applicable; it is the income becoming payable to a non-resident under the transfer. This has been expressed in a more intelligible form in the draft.
(8) The length of the existing section 44D(2) has been reduced in the draft, by replacing the words "any sum paid otherwise than his income", by the words "capital sum", which has been separately defined in draft sub-clause (6).
Notes to clause 97
Existing sections 44E and 44F have been combined in this clause, and certain important changes of substance have been made as follows:-
(1) Existing section 44E(1) applies where the owner of the securities, having agreed to sell or transfer the securities, "by the same or any collateral agreement" agrees to buy back etc., the securities. In practice, however it is difficult for the Department to prove that there was an "agreement" to buy back the securities. Moreover, as a matter of substance, it does not appear to be necessary to insist on the requirement of "same or collateral agreement". The object of the section is to prevent avoidance of tax, and the provision should extend to all cases where the transaction of sale and re-purchase of securities results in such avoidance. The scope of the section has, accordingly, been extended in the draft [see sub-clause (1)].
(2) It has, however, been made clear in the draft that the provision in the existing section 44E will not apply if there was no avoidance or if the avoidance is not systematic; see draft sub-clause (4) which mentions sub-section (1) specifically.
(3) Existing section 44F, operative part, deals with the cases where a person transfers securities before the declaration of the dividend, thus shifting the right to receive the dividend to another person. The operative part of this section has been incorporated in draft sub-clause (3). An important departure from the existing section has, however, been made; the existing section provides for apportionment, vide sub-section (2), latter half read with sub-section (3). Under it, only the income attributable to the period upto the transfer is deemed to be the income of the transferor. Under the draft, however, the income for the full year will be deemed to be the income of the transferor, vide sub-clause (3), last line. Since the provision is intended to stop avoidance, it should go the full way.
Existing section 44F(2) applies only where the avoidance is "more than 10 per cent of the amount of income-tax" for the year. This requirement has been omitted in the draft, in order to make the provision against avoidance more stringent.
(4) While the operative portion of section 44F thus in finds a place in the draft, the machinery provisions in sub-sections (4), (5) and (6) of that section have been omitted. The notice under section 44F(1) will now be covered by draft sub-clause (7).
Apart from these important changes, the other changes are of very minor nature and need no comments. The existing section 44D(7)(c) relating to dividends deemed to have been distributed to a person has been omitted in view of the form in which section 23A stands after its amendment in 1955.