The Hindu Business Line : Discrimination in ‘grandfathering’

In the draft Direct Taxes Code, grandfathering, that is, continuation of tax incentives enjoyed by taxpayers currently, has been done on a selective basis.

T. N. Pandey

The concept of ‘grandfathering’ in the context of income-tax law in India is new, though in other countries such as the US it has been in use for long. In the draft Direct Taxes Code this concept has been used to imply that the tax incentives/benefits enjoyed by taxpayers will be continued even after the coming into force of the Code. This concept has been explained in Chapter XII of the Discussion Paper in paras 12.22 and 12.23.

Eligible areas

Section 282(2)(n) of the Code provides that taxpayers would continue to be eligible for tax deduction for the remaining period under the following sections of the current Act: Section 80-IA (infrastructure development, power, telecom, etc.); Section 80-IAB (SEZ developers); Section 80-IB (oil and gas, housing, hospital, hotel, etc.); Section 80-IC (units in backward areas); Section 80-ID (hotels and convention centres in heritage sites, etc.); Section 80-IE (unit in north-eastern States); and Section 80-JJA (incentives for industries employing new workmen)

Thus, while entities currently enjoying tax incentives under these sections would continue to benefit for the unexpired period even under the new Code, new units set up on or after April 1, 2011, would not be so eligible.

The relief by way of grandfathering is just and equitable because promises made on the basis of which financial commitments have been made by trade and commerce have to be honoured on the legal theory of ‘promissory estoppel’ and the government could not have escaped the situation of grandfathering in respect thereof.

Selective application

However, what is surprising is that the grandfathering has been done on a selective basis and the spirit of the concept has not been applied in respect of certain areas. The examples are:

(a) The new Code is proposed to be implemented from April 1, 2011. Thus the existing export-oriented undertakings (EOUs) set up in 2002 will lose the benefit for the residual period of one year (that is, up to March 31, 2012) without there being any commitment regarding ‘grandfathering’, which is tantamount to taking away a promised tax holiday without any justification.

(b) Likewise, there is no stipulation that the benefit of Section 10AA (which is not proposed to be carried forward to the Code in its present form but by way of a new Schedule XII) is to be enacted for SEZs, operative from the date of coming into force of the Code, with no relationship with existing Section 10AA will be grandfathered in respect of units set up on or after April 1, 2006.

It would be great hardship for such units if the benefit available for 10 years (5+5) is discontinued after the Code becomes operative.

SEZ developers have invested huge funds on the basis of benefits promised under Section 10AA. Hence, grandfathering in such cases is necessary.

(c) Exemption from payment of Dividend Distribution Tax (DDT) to SEZ developers has not been grandfathered without any apparent reasons.

(d) The Code does not provide for exemption of insurance monies received on or after April 1, 2011, even though policies might have been taken prior to this date, where the premium paid annually has been in excess of 5 per cent of the insured amount.

Hence, such amounts would be liable to tax which would be quite unfair. Grandfathering in such cases is also necessary.

The Code is being marketed as a ‘tax neutral’ law but the aforesaid instances show that it is not so. Hence a re-look in respect of ‘grandfathering’ aspects is necessary.

Discrimination between taxpayers equally situated not only affects honest voluntary compliance but also brings down the credibility of the Government and, hence, needs to be avoided.

(The author is a former chairman of CBDT.)