In this article, I have dealt with the amendments proposed to the Income-tax Act, 1961 (‘the Act’) by the Finance Bill, 2005 (the Bill) in three fields, namely, capital gains, securities transaction tax (STT) and zero coupon bonds (ZCB).
 

Capital Gains

Clauses 17 and 18 make certain consequential amendments to sub-section (3) of sections 54EC and 54ED. At present, capital gains invested in certain securities are eligible for exemption under sections 54EC and 54ED. Sub-section (3) of sections 54EC and 54ED provides that if cost of such securities has been taken into account for the purpose of benefit under section 54EC or 54ED, then no deduction shall be allowed in respect of the same investments under section 88.

The Bill proposes to substitute the existing method of providing tax rebates under section 88 by providing an income-based deduction under section 80C of the Act. Consequently, sub-section (3) of sections 54EC and 54ED are being amended to provide that if cost of securities has been taken into account for the purpose of section 54EC or 54ED, then no deduction shall be allowed in respect of the same investments under section 80C.

Under the proposed section 47(viaa), any transfer of a capital asset by a banking company to a banking institution in the scheme of amalgamation of the banking company with the banking institution sanctioned and brought into force by the Central Government under section 45(7) of the Banking Regulations Act, 1949 shall not attract capital gains tax. For this purpose, the meaning of the terms "banking company" and "banking institutions" in section 5(c) and section 45(15) are adopted. Amendments are also made in section 49 to provide that, in case of such amalgamation, cost of the capital assets to the amalgamating company shall be deemed to be the cost of the asset in the hands of the successor.

The Banking Regulation Act defines a "banking company" to mean a company carrying a business of banking in India. The term "banking institution" is defined to include any banking company and includes State Bank of India and its subsidiary. Co-operative banks have been held not to be banking companies [See Phoenix Impex vs. State of Rajasthan AIR 1998 Raj 100]. Therefore, amalgamation of a co-operative bank into another bank may not fall under this clause.
 

Securities transaction tax

The securities transaction tax is being increased across the board by one-third of the existing rate. The proposed rates are as under:

The Finance Minister in his speech states that rates of STT are widely perceived to be too low.  Less than a year back, while presenting Finance (No. 2) Bill, 2004, original rates of STT had been widely criticized and there was a large-scale dissatisfaction expressed by capital markets operators. Bowing to their pressures, the Finance Minister had reduced the STT rates significantly. Now, in less than a year, the Finance Minister has raised the rates by 33% on the ground that the rates are widely perceived to be too low. There is no mention as to which faction of the industry/society perceives them to be "too low".

Therefore, it is highly desirable in the interest of stability that the STT rates should remain unchanged unless the Finance Minister can properly justify the increase, keeping in mind that the justification has to be more than a statement in the speech.
 

Zero Coupon Bond

A Zero Coupon Bond (ZCB) is a bond:

1. issued by Infrastructure Capital Company (ICC) or Infrastructure Capital Fund (ICF) or Public Sector Company (PSC) on or after 1st June, 2005;

2. in respect of which no payment or benefit is received or receivable before maturity or redemption from ICC, ICF or PSC; and

3. which is notified by the Central Government.

ICC and ICF are given the meanings assigned to them in section 10(23G) of the Act.

ZCB issued on or after 1st June, 2005 will be governed by the amended provisions. Bonds issued before this date will continue to be governed by the existing provisions. If the ZCB issued before 1st June, 2005 is considered to be a deep discount bond, the income from such bond will be assessed as follows:
 

• If the bond is transferred before maturity, as capital gains

• If the bond is surrendered on maturity, as interest

Such treatment will also follow in case of ZCB issued after 1st June, 2005 which does not fulfil the above conditions.

A question arises as to why, apart from ICC and ICF, only ZCB issued by public sector companies can be notified. The Finance Minister in his speech states that the State must be neutral between one form of savings and another. Why then not extend the new taxation scheme to ZCB issued by private sector companies, especially since the Central Government has the power of notification and hence misuse of the scheme can be checked.

Gains arising on transfer of ZCB (not held as stock-in-trade) will be treated as capital gains. ZCB will be regarded as a short-term capital asset in the unlikely event of it being held for a period of less than 12 months before it attains maturity, in which case it will be taxed at the normal rates. It will be regarded as a long-term capital asset if it is held for more than 12 months and will be subject to capital gains tax at 10% plus applicable surcharge and education cess. No indexation will be available. No tax will be deducted at source in respect of income payable on ZCB.

The tax authorities and the assessee have differed over the tax treatment of income arising from ZCB. The CBDT circular has treated the income from these instruments as income rather than capital gains, taxing it in higher income tax brackets. Now, this controversy is put at rest in respect of the notified ZCB.

It is interesting to note that the memorandum explaining the provisions of the Finance Bill states that, with a view to rationalizing the tax treatment of ZCB, the income on transfer of ZCB is proposed to be treated as capital gains. It is further stated that long-term capital gains tax on ZCB will be subject to tax "if the tax-payer does not claim indexation benefit". Thus, the legislature has presumed that indexation benefit is available to the tax-payer in respect of ZCB, overlooking the third proviso to section 48 which provides that no indexation benefits are available to any bonds other than capital index bonds issued by the Government.

The scheme of taxation of capital gains is generally that if indexation of cost is granted, then reduced tax rate does not apply; if indexation is not granted, reduced rate applies. By granting a reduced rate to ZCB, the legislature has discriminated between ZCB and other bonds, which goes against the avowed purpose of maintaining parity amongst savings instrument of public and private sectors.

It is also proposed that the deduction of the discount will be available to the issuer calculated on a pro rata basis over the period of life of the ZCB, subject to rules to be prescribed in this regard. The rules will be prescribed by the Central Government. One hopes that the Central Government does not prescribe a complicated formula for calculating the pro rata discount based on IRR or similar factor. If this is done, it will not only be difficult to calculate the amount of deduction for the year, but it will be even more difficult to explain such calculation to the tax authorities. This has the potential to give rise to litigation. One therefore wonders whether at all there is any need to provide for calculation of the pro rata discount "in the prescribed manner". Rather, it would be much better to provide for pro-rating on a simple basis such as, say, equally over the life of ZCB. This would save the trouble that
the Central Government may face in
devising a formula and assessees in implementing it.

Therefore, the following amendments should be made when the Bill is enacted:
 

• Private sector company should be allowed to issue ZCB on the same terms on which a public sector company can issue ZCB; and

• Discount on ZCB should be pro rated equally over the life of ZCB. In the alternative, a simple method to calculate the deduction may be prescribed.
   

Conclusion

Let me conclude by saying that the suggestions made above are minor issues as compared to the significant issues arising out of fringe benefits tax, banking cash withdrawal tax, etc. Nevertheless, they are issues that will affect the tax-payers to some extent and, therefore, the same must be addressed before the Bill is enacted.