ASSESSEES HAVE A CHOICE BETWEEN SECTION 35AD AND VARIOUS OTHER SECTIONS OF CHAPTER VI-A OF INCOME TAX ACT.

The provisions of Section 35AD of Income tax Act, 1961 were inserted by Finance Act, 2009 with a view to granting certain invest-linked incentives to assessees carrying on a specified business. The amendments proposed to this section by Finance Bill, 2010 aims at: (a) rationalizing certain provisions in respect of an assessee carrying on the specified business of laying and operating a cross-country natural gas or crude or petroleum oil pipeline network; (b) extending the benefits of this section to certain hotels; and (c) denying dual deductions to an assessee in respect of the same business.
It is observed that the provisions proposed with the primary objective of denying dual deductions can be interpreted in such a manner as offers a choice to an assessee to claim the benefit under either of the provisions, whichever is more beneficial to him – a privilege which was not available earlier. However, the exercise of such a choice is limited by another proposed amendment to Section 80A of the Act.
In respect of this provision, in my article published on the website of “Taxman” and also in its Budget issue (Vol. 181, Part 3, from pages 88 to 97), I had opined that the said investment-linked tax incentives were illusory being no better than an accelerated depreciation. After discussing in detail the illusory nature of the tax incentive on pages 93 to 96, I had concluded in para 3 of page 96, that:
“Undoubtedly, the profit-linked deductions are better than the proposed investment-linked incentive. So, if a choice is given to an assessee to choose between a deduction under section 35AD and other provisions of computation of income read with various deductions available under Chapter VI-A, many assessees would prefer the later.”
The assessees are advised to evaluate the alternative benefits/deductions and make a choice after considering all relevant facts and circumstances.
1. Section 35AD in brief as it existed before the proposed amendment:
Section 35AD of Income Tax Act, 1961 (hereinafter referred to as “The Act”) which came into effect from 1st April, 2010 provided that 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. The specified business was defined to mean (a) the business of setting up and operating of cold chain facility; (b) the business of setting up and operating a warehousing facility for storage of agricultural produce; and (c) the business of 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. The section allowed one hundred per cent deduction in respect of any capital expenditure incurred, other than expenditure incurred on acquisition of any land or goodwill or financial instrument, during the year by the specified business subject to the provisions contained in the section. Sub-section (2) prescribed the conditions which a specified business was required to fulfill in order to avail the benefits of this section. Sub-section (3) provided that 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”. Sub-section (4) provided that 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. Sub-section (5) prescribed certain eligibility criteria based upon the time of commencement of operations. Other remaining sub-sections (6) to (8) dealt with other ancillary matters.
2. Retrospective amendment of Sub-section (2) rationalizing Pipeline capacity prescribed for use on common carrier basis:
One of the conditions for availing the benefit under section 35AD in the case of 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, is that the specified business ‘has made not less than one-third of its total pipeline capacity available for use on common carrier basis by any person other than the assessee or an associated person. The Petroleum & Natural Gas Regulatory Board has, by regulations, specified a common carrier capacity condition of ‘one-third’ for a natural gas pipeline network and ‘one-fourth’ for petroleum product pipeline network. In order to rationalise the existing condition regarding common carrier capacity, it is proposed to amend sub-section (2) of section 35AD to provide that the proportion of the total pipeline capacity to be made available for use on common carrier basis should be as specified by the said regulations.
The Finance Bill, 2010 proposes to amend sub-clause (c) of clause (iii) of sub-section (2) of the aforesaid section 35AD so as to provide that the proportion of the total pipeline capacity to be made available for use on common carrier basis should be as specified by regulations made by the Petroleum and Natural Gas Regulatory Board.
For this purpose, the Finance Bill, 2010 provides that:
“in sub-section (2), in clause (iii), in sub-clause (c), for the words “one-third of its total pipeline capacity”, the words, brackets and figures “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” shall be substituted;
This amendment will take effect retrospectively from 1st April, 2010 and will, accordingly, apply in relation to assessment year 2010-2011 and subsequent years.
3. Restriction on claiming dual benefit under various provisions of the Act:
The existing provisions contained in sub-section (3) of the aforesaid section 35AD provide that the assessee shall not be allowed any deduction in respect of the specified business under the provisions of Chapter VI-A under the heading “C.-Deductions in respect of certain incomes”.
The Finance Bill, 2010 proposes to substitute sub-section (3) of the aforesaid section so as to provide that 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.
For this purpose, it provides that for sub-section (3), the following sub-section shall be substituted with effect from the 1st day of April, 2011, namely:—
‘(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.’;
These amendments are proposed to take effect from 1st April, 2011 and will, accordingly, apply in relation to the assessment year 2011-12 and subsequent years.
[Note: Another connected and relevant amendment is proposed in Section 80A of the Act also by inserting a new sub-section (7) to provide that where a deduction under any provision of this Chapter under the heading “C.- Deductions in respect of certain incomes” is claimed and allowed in respect of profits of any of the specified business referred to in clause (c) of sub-section (8) of section 35AD for any assessment year, no deduction shall be allowed under the provisions of section 35AD in relation to such specified business for the same or any other assessment year.]
4. Extension of benefit of section 35AD to building and operating a new hotel of a two-star or above category anywhere in India:
Benefits of profit linked deduction under Chapter VI-A of the Income-tax Act are currently available to specified categories of hotels in Uttarakhand and Himachal Pradesh; National Capital Territory and adjacent districts; 22 districts having World Heritage Sites and North-Eastern States, which start functioning before specified dates mentioned in the Act.
In view of the high employment potential of this sector, the Finance Bill, 2010 proposes to include the business of building and operating a new hotel of two-star or above category, anywhere in India, which starts functioning after 1.4.2010 within the purview of “specified business”.
For this purpose, the Finance Bill, 2010 proposes to amend sub-section (5) of the aforesaid section so as to insert a new clause (aa) to provide that the specified business in the nature of building and operating a new hotel of two-star or above category as classified by the Central Government should commence its operation on or after 1st April, 2010.
Consequential amendment is made in sub-section (8) also. In clause (c) thereof, after sub-clause (iii), the following sub-clause is proposed to be inserted with effect from the 1st day of April, 2011, namely:—
“(iv) building and operating, anywhere in India, a new hotel of two-star or above category as classified by the Central Government;”.
These amendments will take effect from 1st April, 2011 and will, accordingly, apply in relation to the assessment year 2011-2012 and subsequent years.
Points to Note: The aforesaid provisions use the words “building and operating” together and so, it means that the benefits of this section are available to only those assessees who undertake both the activities of “building” and “operating” a hotel, simultaneously. If the persons building a hotel and operating it are different, none of them would be entitled to the benefits of this section. To explain further, if a person does not build a hotel, but acquires the same by purchase or on rent or otherwise and then operates the same, he would not be entitled to the benefits of this section. Similarly, a person only building a hotel and thereafter letting it out or allowing any other person to operate the same, would not be entitled to the benefits of this section.
5. Unintended choice between investment-linked deduction under section 35AD and profit-linked deduction under Chapter VI-A of the Act:
From a comparison of the existing and the proposed provisions, it is clear that under the provisions as they existed before the proposed amendment, an assessee carrying on a specified business was totally debarred from claiming any deduction under any other provisions of Chapter VI-A under the heading “C.-Deductions in respect of certain incomes”. In other words, he could claim deduction only under section 35AD and not under any other provisions. On the other hand, the proposed amendments stipulate that 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.
Thus, the proposed amendment of sub-section (3) of section 35AD seeks to prevent an assessee from claiming dual deductions in respect of same business.
It is important to note in this connection that the provisions imposing restrictions on dual claims of benefits in respect of same benefit can be interpreted to mean that if an assessee carrying on a specified business does not claim a deduction under section 35AD, he can, very well, claim deduction under other provisions of Chapter VI-A of the Act if such provisions exist in the said Chapter and if the exercise of such a choice is more beneficial in his case.
Memorandum Explaining the Finance Bill envisaged the putting of a restriction on dual benefits only and so, the aforesaid choice is considered to be unintended.
6. Cases where the assessees have a choice and whether or not they can exercise the same?
In the above premises and also considering another proposed amendment of Section 80A of the Act (stated hereinabove), it is necessary, at this stage, to examine whether or not an assessee who is entitled to deductions in respect of a specified business under section 35AD is also entitled to any deduction under Chapter VI-A the Act and if so, whether or not he can exercise a choice between the two:
(A) Regarding the business of setting up and operating a cold chain facility:
The business of setting up and operating a cold chain facility is considered as a “specified business” for the purposes of section 35AD by virtue of provisions contained in sub-clause (i) of clause (c) of sub-section (8) of the section and so, the expenditure of capital nature incurred, wholly and exclusively, for the purpose of such business is allowable as a deduction. Specified percentage of profits of an undertaking engaged in the case of a business of setting up and operating a cold chain facility for agricultural produce is exempt under sub-section (11) of section 80-IB of the Act if the undertaking begins to operate on or after 1st day of April 1999 but before the 1st day of April, 2004. The period of exemption varies according to the status of the assessee. Thus, in respect of the aforesaid business, investment-linked deduction is available to an assessee under section 35AD and profit-linked deduction is available under section 80-IB.
As stated above, an assessee cannot claim dual benefits under the aforesaid two sections as per the proposed amendment to sub-section (3) of section 35AD. It is also clear that profit-linked deduction under section 80-IB is available to those undertakings who began to operate before 1st day of April, 2004 and so, new entrants to this business are not entitled to claim deduction under section 80-IB. But as the deduction under this section is available for ten consecutive years (or twelve consecutive years in case of a co-operative society), those assessees who commenced such business on or after 1st April, 2001 (or 1st April, 1999 in case of co-operative societies) may have remaining few years for which they are entitled to such deduction. But they also cannot switch over to claim benefits under section 35AD as the proposed amendments to Section 80A contain necessary restrictive provisions.
To conclude, an assessee carrying on the “business of setting up and operating a cold chain facility” does not have any choice either to claim deductions under section 35AD or under section 80-IB.
(B) Regarding the business of setting up and operating a warehousing facility for storage of agricultural produce:
The business of setting up and operating a warehousing facility for storage of agricultural produce is considered as a “specified business” for the purposes of section 35AD by virtue of provisions contained in sub-clause (ii) of clause (c) of sub-section (8) of the section and so, the expenditure of capital nature incurred, wholly and exclusively, for the purpose of such business is allowable as a deduction. Specified percentage of profits of an undertaking engaged in the case of a business of setting up and operating a cold storage plant is exempt under sub-section under clause (iii) of sub-section (2) of section 80-IB of the Act if the undertaking begins to operate such a plant at any time during the period beginning from 1st day of April 1991 and ending on the 31st day of March, 2005. Although the two activities of “warehousing” and that of a “cold storage plant” are not identical and overlap each other in some respects, in respect of the aforesaid business, investment-linked deduction may be claimed by an assessee under section 35AD and profit-linked deduction under section 80-IB.
As stated hereinabove, an assessee cannot claim dual benefits under the aforesaid two sections as per the proposed amendment to sub-section (3) of section 35AD. It is also clear that profit-linked deduction under section 80-IB is available to those undertakings who began to operate before 31st day of March, 2005 and so, new entrants to this business are not entitled to claim deduction under section 80-IB. But as the deduction under this section is available for ten consecutive years (or twelve consecutive years in case of a co-operative society), those assessees who commenced such business on or after 1st April, 2002 (or 1st April, 2000 in case of co-operative societies) may have remaining few years for which they are entitled to such deduction. But they also cannot switch over to claim benefits under section 35AD as the proposed amendments to Section 80A contain necessary restrictive provisions.
To conclude, an assessee carrying on the “business of setting up and operating a warehousing facility for storage of agricultural produce” does not have any choice either to claim deductions under section 35AD or under section 80-IB.
(C) Regarding the business of laying and operating a cross-country natural gas or crude or petroleum pipeline network for distribution, including storage facilities being an integral part of such network:
The business of laying and operating a cross-country natural gas or crude or petroleum pipeline network for distribution, including storage facilities being an integral part of such network is considered as a “specified business” for the purposes of section 35AD by virtue of provisions contained in sub-clause (iii) of clause (c) of sub-section (8) of the section and so, the expenditure of capital nature incurred, wholly and exclusively, for the purpose of such business is allowable as a deduction. Specified percentage of profits of an undertaking engaged in the case of a similar business is exempt under sub-section under clause (vi) of sub-section (4) of section 80-IA of the Act. So, in respect of the aforesaid business, investment-linked deduction may be claimed by an assessee under section 35AD and profit-linked deduction under section 80-IB.
Sub-Section (5) of section 35AD contemplates a further condition that the aforesaid specified business must commence its operation on or after 1st April, 2007 and so, new entrants to the said business claim deduction under either of the provisions.
As stated hereinabove, an assessee cannot claim dual benefits under the aforesaid two sections as per the proposed amendment to sub-section (3) of section 35AD and that the assessees who have already claimed deduction under section 80-IA cannot switch over to section 35AD as the proposed amendments to Section 80A contain necessary restrictive provisions.
(D) Regarding the business of building and operating, anywhere in India, a new hotel of two-star or above category as classified by the Central Government:
The business of building and operating, anywhere in India, a new hotel of two star or above category as classified by the Central Government, will be considered as a “specified business” for the purposes of section 35AD by virtue of the proposed provisions contained in sub-clause (iv) of clause (c) of sub-section (8) of the section and so, the expenditure of capital nature incurred, wholly and exclusively, for the purpose of such business will be allowable as a deduction.
Various kinds of hotels having various locations and various period of commencement are eligible for profit-linked deductions under Chapter VI-A as follows:
(a) Under clause (i) of sub-section (2) of section 80-ID of the Act, any undertaking engaged in the business of hotel located in the specified area (i.e. National capital Territory of Delhi and the districts of Faridabad, Gurgaon, Gautam Budh nagar and Ghaziabad) is entitled to deduction if the hotel is constructed and has started or starts functioning at any time during the period beginning on the 1st day of April, 2007 and ending on the 31st day of March, 2010.
(b) Under clause (iii) of sub-section (2) of section 80-ID of the Act, any undertaking engaged in the business of hotel located in the specified district having a World Heritage Site, is entitled to deduction if the hotel is constructed and has started or starts functioning at any time during the period beginning on the 1st day of April, 2008 and ending on the 31st day of March, 2013.
(c) Under section 80-IE, an undertaking which has, during the period beginning on the 1st day of April, 2007 and ending before the 1st day of April, 2017, begun or begins, in any of the North Eastern States, to carry on any eligible business, is entitled to profit-linked deduction. Such an eligible business includes a hotel of not below two-star category.
As stated hereinabove, an assessee cannot claim dual benefits under the aforesaid two sections as per the proposed amendment to sub-section (3) of section 35AD and that the assessees who have already claimed deduction under section 80-IA cannot switch over to section 35AD as the proposed amendments to Section 80A contain necessary restrictive provisions.
But the new entrants covered by para (b) and (c) above can exercise the choice of claiming deduction either under section 35AD or under section 80-IA of the Act.
6. Which is better alternative – section 35AD or Chapter VI-A?
It need not be mentioned that in case of corporate assessees, the deduction available for expenditure of capital nature cannot be debited to Profit & Loss Account as the accounts are required to be prepared in accordance with the generally accepted accounting principles. There being no provision for adjustment of such deduction while calculating the “Book Profit” under section 115JB (i.e. the Minimum Alternative Tax provisions), the corporate assessees will have to pay MAT (the rate of which is proposed to be increased by the said Finance Bill) notwithstanding the allowance of such expenditure in normal computation of taxable income. On the other hand, depreciation debited to Profit & Loss Account is deductible while calculating the said “Book Profit”. This fact alone tilts the balance in favour of a deduction under Chapter VI-A in case of corporate assessees.
Apart from above, attention of the readers is drawn to my article under the title “Investment-linked tax incentive for specified business under section 35AD – an illusory benefit”, published on the website of “Taxman” and also in its Budget issue (Vol. 181, Part 3, from pages 88 to 97) wherein I had opined that the said investment-linked tax incentives were illusory being no better than an accelerated depreciation. After discussing in detail the illusory nature of the tax incentive on pages 93 to 96, I had concluded in para 3 of page 96, that:
“Undoubtedly, the profit-linked deductions are better than the proposed investment-linked incentive. So, if a choice is given to an assessee to choose between a deduction under section 35AD and other provisions of computation of income read with various deductions available under Chapter VI-A, many assessees would prefer the later.”
So, an assessee should evaluate and exercise the choice between the two sets of provisions according to the particular facts and circumstances of his case.