Finance Bill 2011 -Amendments in section 35AD and their implications with related provisions of Section 73A about set off of loss of specified business.

[C.A. DEV KUMAR KOTHARI]

The following amendments are proposed in the section 35AD with highlights and catch words in first column and analysis of impact in the second column of the table:

Proposed amendments  vide the FB 2011	Impact/ analysis
6. In section 35AD of the Income-tax Act,—
(a) in sub-section (5), with effect from the 1st day of April, 2012,—
(i) in clause (ac), the word "and" occurring at the end shall be omitted;	This is simply to add two new items of specified business w.e.f. 01.04.2012.
(ii) after clause (ac), the following clauses shall be inserted, namely:—
"(ad) on or after the 1st day of April, 2011, where the specified business is in the nature of developing and building a housing project under a scheme for affordable housing framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed;	New eligible and specified business in nature of affordable housing projects etc.
(ae) on or after the 1st day of April, 2011, in a new plant or in a newly installed capacity in an existing plant for production of fertilizer; and";	New  eligible and specified business for production of fertilizer in new plant or  a newly installed capacity in an existing plant .
(iii) in clause (b), for the words, brackets and letters "and clause (ac)", the words, brackets and letters "clause (ac), clause (ad) and clause (ae)" shall be substituted;	This is consequential to insertion of new  eligible specified businesses.
(b) in sub-section (8), in clause (c),—	Amendment in the meaning of “specified business” [not necessarily an eligible and specified business under sub-section (5)]
(i) in sub-clause (iv), for the words "new hotel", the word "hotel" shall be substituted;	Condition of hotel being new is omitted this is intended to   facilitate set off of loss w.e.f.01.04.2011 because any other  effective date is not mentioned, and  this is also so stated  in Memorandum
(ii) in sub-clause (v), for the words "new hospital", the word "hospital" shall be substituted;	Condition of hospital  being new is omitted this is intended to  facilitate set off of loss w.e.f. 01.04.2011. because any other  effective date is not mentioned, this is also so stated  in memorandum
(iii) after sub-clause (vi), the following sub-clauses shall be inserted with effect from the 1st day of April, 2012, namely:—	New clauses w.e.f. 01.04.2012
"(vii) developing and building a housing project under a scheme for affordable housing framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed;	Consequential
(viii) production of fertilizer in India;".	Consequential

From the Memorandum and notes:

Investment linked deduction in respect of specified businesses

Under the existing provisions of section 35AD of the Income-tax Act, investment-linked tax incentive is provided by way of allowing hundred per cent. deduction in respect of any expenditure of capital nature (other than on land, goodwill and financial instrument) incurred wholly and exclusively, for the purposes of the “specified business”. Currently, the following specified businesses are eligible for availing investment-linked deduction under section 35AD(8)(c):

(i) setting up and operating a cold chain facility;

(ii) setting up and operating a warehousing facility for storage of agricultural produce;

(iii) laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of such network;

(iv) building and operating, anywhere in India, a new hotel of two-star or above category as classified by the Central Government;

(v) building and operating, anywhere in India, a new hospital with at least one hundred beds for patients;

(vi) developing and building a housing project under a scheme for slum redevelopment or rehabilitation framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed.

It is proposed to include two new businesses as “specified business”, i.e.,

(a) developing and building a housing project under a scheme for affordable housing framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed; and

(b) production of fertilizer in India.

The dates of commencement of the “specified business” as an eligibility condition are detailed in section 35AD(5). It is proposed that the date of commencement of operations in the case of the two “specified businesses” of affordable housing projects and production of fertilizer in a new plant or in a newly installed capacity in an existing plant shall be on or after 1st April, 2011.

These amendments will take effect from 1st April, 2012 and will, accordingly, apply in relation to the assessment year 2012-13 and subsequent years.

Under section 73A, any loss of a “specified business” (under section 35AD) is allowed set-off against profit and gains of any other “specified business”. In order to remove any ambiguity in this regard in respect of the business of hotels and hospitals, it is proposed to remove the word “new” from the definition of “specified business” in the case of hotels and hospitals under section 35AD(8)(c). With this, the loss of an assessee on account of a “specified business” claiming deduction under section 35AD would be allowed to be set off against the profit of another “specified business” under section 73A, whether or not the latter is eligible for deduction under section 35AD. Therefore, an assessee who currently operates a hospital or a hotel would be able to set off the profits of such business against the losses, if any, of a new hospital or new hotel which begins to operate after 1st April, 2010 and which is eligible for deduction of expenditure under section 35AD.

This amendment will take effect retrospectively from 1st April, 2011 and will, accordingly, apply in relation to the assessment year 2011-12 and subsequent years.

[Clause 6]

Summary of impact of amendments:

1. New specified businesses with effect from the 1st day of April, 2012:

Two new businesses popularly called (a) affordable housing projects and (b)  production of fertilizer in new unit or newly installed capacity in existing unit  will also be specified businesses.  For details please see the proposals and provisions as they will stand after amendment.

2. Changes in relation to set off of loss w.e.f. 01.04.2011:

In view of amendment of S. 35AD(8)(c) clauses (iv) and (v) (by omitting conditions of hotel and hospital being new) and read with section 73A,  the loss of an assessee on account of a “specified business” being  new hotel or new hospital  {vide (S.35AD (5) (aa) and (ab)} the condition of being new is omitted w.e.f. 01.04.2011. Therefore, an assessee who currently operates a hospital or a hotel being  qualified as ‘specified business’ within meaning u/s 35AD (8)( c ),  would be able to set off the profits of such business against the losses, if any, of a new eligible hospital or new eligible hotel which begins to operate after 1st April, 2010 and which is eligible for deduction of expenditure under section 35AD.

Thus, profit of old hotel and hospitals of specified description, falling within meaning of specified business, can be set off against loss of any new specified business, eligible for deduction u/s 35AD (3) read with subsection (5).

The difference between Sub-section (5) and sub – section 8(c):

We can say that sub-section (5) concerns a specified business which is eligible to claim deduction of capital expenditure. Let us call ‘eligible specified business’ who can claim capital expenditure as allowable for deduction.

Clause (c) of sub- section 8 prescribes meaning of ‘specified business’ (not necessarily eligible specified businesses. We find that only in case of hotel and hospital the condition of new was added. In case of other categories of ‘specified businesses’ there was no such condition of being new. Even in respect of newly added two specified businesses there is no condition of being new for this purpose.

Therefore a set off is permissible as follows:

Profit of any ‘specified business’  can be set off against loss of any specified business whether be an eligible specified business or not.

Thus, profit or loss of any businesses as specified in S. 35AD (8) (c) (i)- (viii)   can be set off against each other irrespective of fact that any such business is eligible specified business or not.

It is pertinent that in the meaning of ‘specified business’ u/s 35AD(8) (c) the condition of business being new was only in respect of specified type of hotels and hospitals. In case of other categories of specified business there was no such conditions of being new.   Even in respect to newly inserted two specified business, we find that condition for being eligible for allowance of capital expenses, is impliedly new. However , in meaning of specified business, there is no such condition or implication. Therefore, loss of a new fertilizer plant or newly installed capacity in existing plant claiming deduction of capital expenses will be eligible for set off against any specified business under said clause (c )

This amendment will take effect retrospectively from 1st April, 2011 and will, accordingly, apply in relation to the assessment year 2011-12 (relevant to previous year ended on 31.03.11) and subsequent years.

Section as it will be after proposed amendments will read as follows (with highlights):

[35AD. Deduction in respect of expenditure on specified business

(1) An assessee shall be allowed a deduction in respect of the whole of any expenditure of capital nature incurred, wholly and exclusively, for the purposes of any specified business carried on by him during the previous year in which such expenditure is incurred by him:

Provided that the expenditure incurred, wholly and exclusively, for the purposes of any specified business, shall be allowed as deduction during the previous year in which he commences operations of his specified business, if—

     (a)   the expenditure is incurred prior to the commencement of its operations; and

     (b)   the amount is capitalized in the books of account of the assessee on the date of commencement of its operations.]

(2) This section applies to the specified business which fulfils all the following conditions, namely:—

      (i)   it is not set up by splitting up, or the reconstruction, of a business already in existence;

     (ii)   it is not set up by the transfer to the specified business of machinery or plant previously used for any purpose;

    (iii)   where the business is of the nature referred to in sub-clause (iii) of clause (c) of sub-section (8), such business,—

           (a)   is owned by a company formed and registered in India under the Companies Act, 1956 (1 of 1956) or by a consortium of such companies or by an authority or a board or a corporation established or constituted under any Central or State Act;

           (b)   has been approved by the Petroleum and Natural Gas Regulatory Board established under sub-section (1) of section 3 of the Petroleum and Natural Gas Regulatory Board Act, 2006 ^[22] (19 of 2006) and notified by the Central Government in the Official Gazette in this behalf;

           (c)   has made not less than ^[23][such proportion of its total pipeline capacity as specified by regulations made by the Petroleum and Natural Gas Regulatory Board established under sub-section (1) of section 3 of the Petroleum and Natural Gas Regulatory Board Act, 2006 (19 of 2006)] available for use on common carrier basis by any person other than the assessee or an associated person; and

           (d)   fulfils any other condition as may be prescribed.

(3) The assessee shall not be allowed any deduction in respect of the specified business under the provisions of Chapter VIA under the heading "C.—Deductions in respect of certain incomes".

The following sub-section (3) is being substituted for the sub-section (3), above, by the Finance Act, 2010, w.e.f. 1-4-2011:

"(3) Where a deduction under this section is claimed and allowed in respect of the specified business for any assessment year, no deduction shall be allowed under the provisions of Chapter VI-A under the heading “C.—Deductions in respect of certain incomes” in relation to such specified business for the same or any other assessment year."

(4) No deduction in respect of the expenditure referred to in sub-section (1) shall be allowed to the assessee under any other section in any previous year or under this section in any other previous year.

(5) The provisions of this section shall apply to the specified business referred to in sub-section (2) if it commences its operations,—

     (a)   on or after the 1st day of April, 2007, where the specified business is in the nature of laying and operating a cross-country natural gas pipeline network for distribution, including storage facilities being an integral part of such network;  ^24][and]

^[25][(aa)  on or after the 1st day of April, 2010, where the specified business is in the nature of building and operating a new hotel of two-star or above category as classified by the Central Government;

   (ab)   on or after the 1st day of April, 2010, where the specified business is in the nature of building and operating a new hospital with at least one hundred beds for patients;

   (ac)   on or after the 1st day of April, 2010, where the specified business is in the nature of developing and building a housing project under a scheme for slum redevelopment or rehabilitation framed by the Central Government or a State Government, as the case may be, and which is notified by the Board in this behalf in accordance with guidelines as may be prescribed;

"(ad) on or after the 1st day of April, 2011, where the specified business is in the nature of developing and building a housing project under a scheme for affordable housing framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed;

(ae) on or after the 1st day of April, 2011, in a new plant or in a newly installed capacity in an existing plant for production of fertilizer; and";

     (b)   on or after the 1st day of April, 2009, in all other cases not falling under clause (a), clause (aa) clause (ab) "clause (ac), clause (ad) and clause (ae)"].

(6) The assessee carrying on the business of the nature referred to in clause (a) of sub-section (5) shall be allowed, in addition to deduction under sub-section (1), a further deduction in the previous year relevant to the assessment year beginning on the 1st day of April, 2010, of an amount in respect of expenditure of capital nature incurred during any earlier previous year, if—

 (a) the business referred to in clause (a) of sub-section (5) has commenced its operation at any time during the period beginning on or after the 1st day of April, 2007 and ending on the 31st day of March, 2009; and

     (b)   no deduction for such amount has been allowed or is allowable to the assessee in any earlier previous year.

(7) The provisions contained in sub-section (6) of section 80A and the provisions of sub-sections (7) and (10) of section 80-IA shall, so far as may be, apply to this section in respect of goods or services or assets held for the purposes of the specified business.

(8) For the purposes of this section,—

     (a)   an "associated person", in relation to the assessee, means a person,—

            (i)   who participates, directly or indirectly, or through one or more inter-mediaries in the management or control or capital of the assessee;

           (ii)   who holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in the capital of the assessee;

          (iii)   who appoints more than half of the Board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of the assessee; or

          (iv)   who guarantees not less than ten per cent of the total borrowings of the assessee;          

(b)        "cold chain facility" means a chain of facilities for storage or transportation of agricultural and forest produce, meat and meat products, poultry, marine and dairy products, products of horticulture, floriculture and apiculture and processed food items under scientifically controlled conditions including refrigeration and other facilities necessary for the preservation of such produce;

     (c)   "specified business" means the any one or more of the following business, namely:—

            (i)   setting up and operating a cold chain facility;

           (ii)   setting up and operating a warehousing facility for storage of agricultural produce;

          (iii)   laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of such network;

    ^[27][(iv)   building and operating, anywhere in India, a hotel of two-star or above category as classified by the Central Government;

           (v)   building and operating, anywhere in India, a hospital with at least one hundred beds for patients;

          (vi)   developing and building a housing project under a scheme for slum redevelopment or rehabilitation framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed;]

         "(vii) developing and building a housing project under a scheme for affordable housing  framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed;

             (viii) production of fertilizer in India;".

(d) any machinery or plant which was used outside India by any person other than the assessee shall not be regarded as machinery or plant previously used for any purpose, if—

           (i)   such machinery or plant was not, at any time prior to the date of the installation by the assessee, used in India;

           (ii)   such machinery or plant is imported into India from any country outside India; and

          (iii)   no deduction on account of depreciation in respect of such machinery or plant has been allowed or is allowable under the provisions of this Act in computing the total income of any person for any period prior to the date of the installation of the machinery or plant by the assessee;

     (e)   where in the case of a specified business, any machinery or plant or any part thereof previously used for any purpose is transferred to the specified business and the total value of the machinery or plant or part so transferred does not exceed twenty per cent of the total value of the machinery or plant used in such business, then, for the purposes of clause (ii) of sub-section (2), the condition specified therein shall be deemed to have been complied with;

     (f)   any expenditure of capital nature shall not include any expenditure incurred on the acquisition of any land or goodwill or financial instrument.]

Provisions relating to carry forward of loss- there is no change, but provision is very harsh and may be impracticable in many cases:

[73A. Carry forward and set off of losses by specified business

(1) Any loss, computed in respect of any specified business referred to in section 35AD shall not be set off except against profits and gains, if any, of any other specified business.

(2) Where for any assessment year any loss computed in respect of the specified business referred to in sub-section (1) has not been wholly set off under sub-section (1), so much of the loss as is not so set off or the whole loss where the assessee has no income from any other specified business, shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and—

      (i)   it shall be set off against the profits and gains, if any, of any specified business carried on by him assesssable for that assessment year; and

     (ii)   if the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on.]

Authors comments about facility for set off of loss:

Section 73A imposes a restriction that loss of a specified business can be set off only against profit of any other specified business. This is not justified for the following reasons:

1. A specified business ( as defined in S.35AD (8) (c) may be a new business or an existing old business. For example, there are many fertilizer producing companies having accumulated losses. After insertion of production of fertilizer in meaning of specified business, the loss of old existing fertilizer plants will cease to be eligible for set off except against income of any specified business.  For example in case of Duncan Agro Ltd. the loss of fertilizer business will not be eligible for set off against income of its tea business. Author feels that this is not intention.
2. Specified businesses are capital intensive business having long gestation period. Even when normal depreciation is allowed, such businesses have no taxable profit in many initial years (unless profits are transferred from other business). This is because such businesses generally break even after a long period of at least 5-6 years. Therefore, having taxable profit is with very less probability.  
3. It will require at least two specified businesses. Out of which one can be eligible for special deductions  allowed u/s 35AD and another can be specified  business which has not availed or which was not eligible for deduction u/s 35AD. E.G. old fertilizer plant.
4. Deduction of capital expenditure is allowed as an incentive to make investment in specified businesses and that too within specified period. Therefore, there should not be any restriction on loss of such business to be set off only  against any other specified business only.

Therefore, author feels that section 73A should be omitted.