In the last few years, India has been engaged in refining its tax policies so that the country becomes an attractive destination for Foreign Direct Investment (FDI) and invites the establishment of new industries. The rate of corporate taxes in India was higher, especially between the countries aligned with manufacturing processes like Vietnam and Thailand. High tax rates have adverse effects on businesses, specifically discouraging the beginning process since it influences the bottom line of profitability.
The Indian Government came up with the Taxation Laws (Amendment) Act of 2019 that introduces section 115BAB having huge tax benefits for new domestic manufacturing units. At that time section 115BAA was also introduced, giving a lesser rate of taxation than existing domestic companies provided they forgo some of the exemption and deduction offered to them. These reforms harmonize with each other so that they can ease the tax regime for new businesses as well as old businesses.
By October 2023, the Indian Income Tax Act, 1961 was amended to add section 115BAB to the act to give a much-needed boost to the manufacturing sector as well as generating employment for citizens of India by attracting several national as well as international investors. All newly incorporated domestic manufacturing companies can avail reduced tax rates based on the following conditions, which are mentioned below.
This provision shall apply to any company incorporated in India on or after 01 April 2019 and commencing manufacturing activities in India between 01 April 2019 and 31 March 2023, and which has made an eligible equity investment in the relevant manufacturing activity. With this provision, the Indian Government aims at building upon the manufacturing base of India and developing skills, trade, and employment opportunities.
What is Section 115BAB of the Income Tax Act of 1961?
The Government of India introduced Section 115BAB through the 2019 Taxation Laws (Amendment) Ordinance, which was later passed as the 2019 Taxation Laws (Amendment) Act. The primary intention behind this section was to attract more setting up of new ventures through a lower rate of corporate tax. The main aim of the government was to improve the industrial level of the country so as to create job employment and more working capacity for the country’s productions.
Section 115BAB gives a corporate tax rate cut to 15% (plus any relevant surcharge and cess) for the newly incorporated domestic manufacturing companies, which works out to an effective rate of about 17.16%. This concessional rate is less than the standard rate of 30% and is applicable to all enterprises carrying on business in India. To avail of this benefit, corporates do not qualify for merely this lower tax rate; they also need to qualify for specific aspects such as the date of incorporation of companies, business activities, and assets.
This is because of a rather competitive tax rate pencil of taxation that has made India one of the most favored places in the world in which to start one’s manufacturing businesses and amongst the best corporate tax regimes of the world.
Applicability of the Section 115BAB of the Income Tax Act, 1961 in India
Section 115BAB of the Indian Income Tax Act refers to newly set up domestic manufacturing units that commence operation after October 1, 2019, and produce or supply goods before March 31, 2024. In a proper sense of the word, this stated provision seems to provide these rules that are applicable only to businesses that are now set up with a particular objective to carry out such manufacturing activities within the limitation provided for this duration only.
Access to the lower tax rate is available only in case the enterprise does not claim any other incentive or exemption apart from the one available under the Income Tax Act, like deductions provided under Sections 10AA, 32AD or any other provision allowing for profit-linked deductions. This is basically with an intent to have a transparent tax regime that is free of all exemptions and special deductions.
Eligibility and the Companies Covered Under Section 115BAB of the Income Tax Act, 1961
Section 115BAB of the Income Tax Act, 1961, promotes newly incorporated domestic manufacturing firms with the objective of simplifying the ‘Make in India’ program initiated by the government, among other objectives. Companies will be eligible to get the concessional corporate tax rate of 15% or around 17.16%, effective in light of prevailing surcharges and cesses, subject to such conditions.
To avail of the benefits under Section 115BAB, a company must meet the following criteria:
- New Manufacturing Enterprises: It is relevant only to the domestic firms, which are incorporated on or after 1st October 2019 and intend to set up a manufacturing or production plant. It is in the regulation of the enterprise that it has to start the manufacturing or production of goods by 31st March 2024.
- Exclusivity to Manufacturing and Production: The venture is only restricted to the production or manufacturing of commodities and does not extend beyond that e.g. it does not carry out any trading activities, provision of services or any other non-manufacturing activities. The venture does not stretch to any sector or activities such as mining, software development, energy generation, and even roads upkeep.
- Restrictions on Plant and Machinery Utilization: All the equipment that will be used during production should be brand new. Already used production machines, equipment and devices can be introduced only if their value is below 20% of the total value of the plant and machinery. Importation of second hand machines, which have never been used in India, is also permitted.
- Companies excluded from the applicability of Section 115BAB: Such enterprises whose business operations do not consist of the manufacture or production of consumable goods are excluded. Corporates that are eligible for any type of income tax relief or relief to be discharged as Seal through Section 10AA providing financial inputs that are to be used in investments in assets in the focused East region under Section 32AD and profit-based allowances as provided in VI-A are also excluded. Also, companies involved in businesses of software development services, mining activities, business related to generation, transmission or distribution of electricity, maintenance or repair of infrastructural facilities and all such activities that do not fall into any kind of manufacturing are also not eligible for the benefit of this section.
Illustration
To appreciate how Section 115BAB stands, let us use the following illustration.
Given that:
- ABC Private Limited was incorporated on November 1st 2019.
- The company, however, started opening its first manufacturing plant on February 15th, 2023.
- The company has brand new machines, with machinery used being less than 20% of the total cost for plant and equipment.
- In the line of operations, the company does not experience any other deduction advantage, such as section 32AD or 10AA.
- FY 2023-2024 Gross Annual Turnover of the company is Rs. 10 Crore.
Tax Computation:
ABC PRIVATE LIMITED will be taxable at the rate of 15% as under Section 115BAB, which contains a 10% surcharge and a 4% Cess over and above the income tax and surcharge.
Crown tax for the above base, of which 15% of 10 crore is available and amounts to 1.5 crore. Capping which is 10% comes to be 0.15 crore.
CESS (over and above the tax at the rate of 4%) =0.066 crore
The total amount of tax payable shall be the same as Rs. 1.716 crore.
Here, we can see how Section 115BAB would play a crucial role in terms of the tax payable since it is ‘reasonably much lower’ than the usual corporate tax, which is always between 25% and 30%.
Conclusion
A strategic initiative, Section 115BAB is aimed to increase the status of India as a global manufacturing destination. The provision makes India an attractive destination for firms who would want to set up their manufacturing operations by providing the highest competitive tax rate. However, the eligibility criteria are quite stringent, so the provisions do not allow misuse of this benefit. Further, the section makes the tax structure simpler for the said companies as it disallows any additional deductions.
The newly incorporated manufacturing companies that engage in only manufacturing operations and do not have any other business activities or benefit from other tax advantages come under Section 115BAB. This section intends to offer the said companies a simplified and lower tax structure, which will facilitate growth in India’s manufacturing sector.
Section 115BAB has emerged as another interesting provision in the context of encouraging the growth of the industrial and manufacturing sectors in India. This is to reduce the tax burden on new manufacturing companies with the ultimate intention of building a better industrial base in the country, encouraging foreign direct investment, and job creation in general. Still, for the companies to derive any benefit from this inducement, there are some other qualifications that they have to adhere to, and they also have to restrict themselves to only a manufacturing business. Coupled with other legislative provisions, Section 115BAB will become an important constituent of India’s quest to become a global manufacturing hub.
