GROUP TAXATION

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GROUP TAXATION

• Presentation by
• HAIDER A. PATEL
• The Institute of Chartered Accountants of
  Pakistan
• 30 April 2009

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Group Taxation

• The concept of Group Taxation is quite in vogue
  in many countries of the world specially in the
  European Union countries and United States
• Under the concept a group of related companies is
  permitted to be treated as a single taxpayer
• The concept is designed to reduced the effect
  that the separate existence of related companies
  may have on the aggregate tax liability of the
  group
• It can be attractive to corporate groups because
  it gives them flexibility to organize the
  business and engage in internal restructuring and
  asset transfer without worrying about triggering
  taxation in the process.

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Group Taxation

• Generally group taxation provides the following
  fundamental benefits
• Eliminates income or loss recognition on intra
  group transaction by providing for deferral until
  after the group is terminated or the underlying
  asset leaves the group
• Permits the offset of losses against the profits
  of a related group member. Some countries
  including Pakistan also permits offset of losses
  through Group Relief without actual taxation of
  the group companies as one fiscal unit

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Group Taxation

• The concept of Group taxation has been recently
  introduced in Pakistan through introduction of
  Section 59AA in the Income tax Ordinance, 2001
• The law allows holding companies and its 100
  owned subsidiaries an option to be taxed as one
  fiscal unit
• In order to avail the option the group
  comprising of the holding company and its 100
  owned subsidiaries are required to submit a group
  return of income.

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Group Taxation

• The return is to be filed in the name of the
  holding company declaring the consolidated income
  of the following
• the holding company
• All subsidiaries that have opted for group
  taxation
• The return is to be accompanied by the following
• Consolidated financial statements as required
  under section 237 of the Companies Ordinance,
  1984
• Computation of Income and tax liability

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Group Taxation

• The draft Income tax Rules published through SRO
  301 dated 07 April 2009 further propose the
  filing of the following-
• Besides consolidated accounts the separate
  audited account of every company in the group
  shall be required to be submitted alongwith the
  Group return
• Subsidiary companies would continue to file their
  individual income tax returns in their respective
  jurisdictions alongwith a copy of application for
  group taxation and intimating non taxability of
  the returned income.

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Group Taxation

• The law requires consolidated accounts to be
  submitted alongwith the group return in respect
  of the holding company and its 100 owned
  subsidiary
• On the other hand section 237 of the Companies
  Ordinance, 1984 requires every company having a
  subsidiary to prepare consolidated accounts.
  Under Companies Ordinance, 1984, a company is
  regarded a subsidiary of another company if 50
  or more of its voting rights are held by the
  other company
• This means that if a holding company has more
  than one subsidiary and not all of them are 100
  owned companies, they will have to prepare
  separate consolidated accounts to meet the
  requirement of law in respect of consolidated
  results of the holding company and its 100 owned
  subsidiary which qualify and opt for group
  taxation

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Group Taxation

• 59AA(2) The companies in the group shall give
  irrevocable option for taxation under this
  section as one fiscal unit
• The option for group taxation is irrevocable,
  which perhaps may be interpreted that once opted
  the holding company and its 100 owned subsidiary
  would have to continue to be taxed as one fiscal
  unit
• Rule 231D proposed to be inserted in the Income
  Tax Rules, 2002, however, while listing the
  procedure for filing of application for opting
  for group taxation requires that every holding
  company and its 100 owned subsidiary shall make
  separate application within the first quarter of
  the tax year for which group taxation is opted
  for

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Group Taxation

• 59AA(2) The companies in the group shall give
  irrevocable option for taxation under this
  section as one fiscal unit
• A close look at the wordings of the suggested
  rule, however, can be interpreted to mean that
  the option is to be filed for each tax year and
  is irrevocable for that tax year only
• Divestment by the parent company of its
  shareholding by any extent will render the
  subsidiary ineligible for group taxation as the
  holding companies shareholding would fall below
  100. In such an event the draft rules state that
  the provisions of group taxation would not apply
  to the subsidiary from the tax year in which
  divestment takes place.

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Group Taxation

• 59AA(3) The group taxation shall be restricted to
  companies locally incorporated under the
  Companies Ordinance, 1984 (XLVII of 1984).
• This means that other companies which are
  incorporated and governed under other statutes
  such as banking Companies Ordinance do not have
  the option of Group taxation to be taxed as one
  fiscal unit.

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Group Taxation

• 59AA(4)The relief under group taxation would not
  be available to losses prior to the formation of
  the group.
• Reading the Law in isolation leads to question as
  to a what point of time is to be regarded as the
  time for formation of the Group. Is it the time
  since when the subsidiary company was 100 owned
  by the holding company or the time when the Group
  get itself registered with the SECP under the
  Group Registration Regulation, 2008
• The draft Income Tax Rules elaborates this point
  and explains the formation of the Group is the
  time when the Group exercises the option of Group
  Taxation and registers as such with SECP

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Group Taxation

• The Rules clearly states that no effect will be
  given to losses (including unabsorbed
  depreciation) of subsidiary company brought
  forward from tax years prior to exercise of
  option for group taxation.
• Further a question arises as to availability of
  any un availed losses of the subsidiary company
  that are available at the time the group opted
  for group taxation. In my view the losses will
  elapse after completion of their limitation
  period since freezing of losses is not provided
  for
• However, in my view any unabsorbed depreciation/
  amortization loss will remain available to the
  subsidiary companies since such losses are
  available for carry forward indefinitely. These
  can be absorbed against future stand alone
  taxable income of the subsidiary.

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Group Taxation

• 59AA(5) The option of group taxation shall be
  available to those group companies which comply
  with such corporate governance requirements as
  may be specified by the Securities and Exchange
  Commission of Pakistan from time to time and are
  designated as companies entitled to avail group
  taxation.
• The intention appears to provide the option to
  companies that are compliant to corporate
  governance requirements. This fact would be
  certified by the SECP. Further the law requires
  the SECP to designate companies eligible for
  Group Taxation
• In this regard the SECP has finalized rules for
  the purpose of designating companies for group
  relief purposes. The rules have been issued
  through SRO 1307 dated December 31, 2008.

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Group Taxation

• 59AA(5) The option of group taxation shall be
  available to those group companies which comply
  with such corporate governance requirements as
  may be specified by the Securities and Exchange
  Commission of Pakistan from time to time and are
  designated as companies entitled to avail group
  taxation.
• The SECP has formulated elaborate Group Companies
  Registration regulations, 2008. These Rules lay
  down the procedure and requirement for filing an
  application for registration of a group, its
  registration and any subsequent alteration of
  composition of group
• The regulation also provides regulations for
  designation as a group eligible for availing the
  option of Group Taxation and Group Relief.

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Group Taxation

• Having gone through the concept of Group Taxation
  as provided in the tax law in Pakistan I would
  now like to share with you briefly the salient
  features of Group Taxation in a few countries in
  the world

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Group Taxation
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Group Taxation
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Group Relief

• The concept of Group Relief was introduced
  through Finance Act, 2004 however, the said
  section has undergone major change due to
  impeding problems in implementation and was
  completely substituted through Finance Act, 2007
• The concept of Group Relief allows group
  companies to absorb each others losses subject to
  certain conditions without opting for being taxed
  as one fiscal unit
• Losses can be surrendered by -
• A subsidiary ? Holding company
• A subsidiary ? Another subsidiary of its holding
  company

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Group Relief

• Assessed losses other than capital losses and
  brought forward losses can be surrendered
• The loss surrendered is permitted to be offset
  against business income of the tax year
• If loss surrendered cannot be fully offset in
  that tax year then it can be carried forward for
  offset against the next two tax years business
  income
• Loss surrendered by a subsidiary company that
  remains unabsorbed will revert back for offset
  against its income within the remaining period
  that the loss remains available as per law.

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Group Relief

• Eligible holding requirement

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Group Relief

• The Group Relief available in the shape of
  surrender and absorption of losses is available
  subject to certain conditions which are as
  follows
• Continued ownership for five years of the minimum
  share capital of the subsidiary company as
  discussed in the previous slide
• Company within the group engaged in the business
  of trading not entitled to avail group relief
• In case none of the companies in the group is
  listed, the holding company to get itself listed
  within three years from the year in which loss is
  claimed
• The group companies are locally incorporated
  under the Companies Ordinance, 1984

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Group Relief

• Contd.
• Surrender and claim of loss must have approval of
  the Board of Directors of the respective
  companies
• The subsidiary company continues the same
  business during the period of three years
• All companies to comply with corporate governance
  requirements of SECP and are designated as
  companies entitled to avail group relief
• Any other prescribed condition

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Group Relief

• Several conditions listed above have issues that
  need to be addressed
• The first condition requires continued ownership
  for five year of the minimum required share
  capital. On the other hand the Group Registration
  Regulation, 2008 notified through SRO.1307
  requires shareholding in the past five years at
  this minimum level before designating the group
  eligible for group relief
• The anomaly needs rectified in the SECP
  notification as in my view the law is clear on
  continuity of ownership for the next five years.
  It has been provided in sub-section (5) of
  Section 59B that in case of a disposal of shares
  by the holding company which breaches the minimum
  required shareholding requirement, the benefit in
  tax would be clawed back in the year of
  divestment of share

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Group Relief

• Contd.
• Where none of the company in the group is a
  listed company, it is required that the holding
  company gets itself listed within three years.
  This condition is against the principle of group
  formation as by and large groups would not like
  to keep its investment in a listed company due to
  the risk of hostile takeovers. Therefore, the
  condition should be to require listing of one of
  the company in the group
• Continuity of the same business by the subsidiary
  company for the period of three years. This
  condition also need review as in case the
  subsidiary is making losses the group would like
  to diversify its business to make it viable. If
  trading companies are not desired to avail group
  relief then barring trading business,
  subsidiaries may be permitted to diversify its
  business.

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Group Relief

• Other Features
• Loss claiming company is permitted to transfer
  cash to the loss surrendering company equal to
  the amount of tax payable on the profit which has
  not been paid due to availing of group relief
• The transfer of cash is not recognized as a
  taxable event in the case of both companies
• The transfer of shares between companies and the
  shareholders in one direction would not be
  regarded as a taxable event if the transfer is to
  acquire share capital for formation of the group
  and such transfer is duly approved by SECP or SBP
  as a case may be.

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Group Relief

• Choice of option Group Taxation or Group Relief
• The choice of opting for group taxation or group
  relief would largly depend on the objectives of
  the companies desiring to avail the tax benefits.
  The choice may vary from one case to another
  depending on the peculiar situation of each case
• However, the following factors in my view need to
  be considered
• Exemption is available to interoperate dividend
  payments under Clause (103A) of Part I of Second
  Schedule to companies receiving dividend that
  qualify for group taxation under Section 59AA
• Set off of losses of subisidiary against holding
  company or other subsidiary gains without any
  restrictions
• Adjustment of refunds of one company against the
  tax liability of the other company

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Non Recognition Rules for Restructuring
Transaction

• A group may review its current structure and may
  require restructuring to attain future business
  objectives or perhaps to fulfill the basic
  requirements like minimum shareholding for
  availing group taxation or group relief
• While undertaking restructuring the motive of the
  transaction is not to make profits but to realign
  the group structure for use of existing resources
  in a manner to obtain optimal results
• However, one has to be conscious of the impeding
  tax exposure that the companies may face in the
  event of transfer of assets among the group
  companies or shares among its existing
  shareholders

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Non Recognition Rules for Restructuring
Transaction

• This principle of not recognizing the gains on
  transfer of assets belonging to the same
  shareholders has been upheld in the past even
  when non recognition rules were not provided in
  the statute.
• Under the Income Tax Ordinance, 2001 no
  recognition rules have been provided in Section
  95 to 97A. We will briefly discussed the
  provisions of Section 97 and 97A to understand
  the concept and conditions to be fulfilled to
  avail such non recognition of gain loss on
  transfer of assets

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Non Recognition Rules for Restructuring
Transaction

• Section 97 provides that no gain or loss shall be
  taken to arise when a resident company disposes
  off its assets to another resident company.
  However, to avail this benefit the following
  conditions must be satisfied
• Both companies belong to a wholly-owned group of
  resident companies at the time of the disposal
• The transferee must undertake to discharge any
  liability in respect of the asset acquired
• Any liability in respect of the asset must not
  exceed the transferors cost of the asset at the
  time of the disposal and
• The transferee must not be exempt from tax for
  the tax year in which the disposal takes place.

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Non Recognition Rules for Restructuring
Transaction

• In the event that all conditions are satisfied,
  the following principles would apply
• Characteristic of the assets acquired
• The asset will be treated as having the same
  character as it had in the hands of the
  transferor.
• Cost of the assets acquired
• Depreciable / Amortizable assets The written
  down value
• Stock in trade valued at FMV Fair market value
• All other assets Cost of the asset.

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Non Recognition Rules for Restructuring
Transaction

• Unabsorbed depreciation / amortization
• If the transferor has any unabsorbed depreciation
  / amortization, immediately before disposal, in
  respect of assets transferred, the transferee
  company can claim the unabsorbed amount as a
  deduction allowed, so however that such amount
  shall be considered last.

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Non Recognition Rules for Restructuring
Transaction

• The provisions of Section 97 require that the
  assets be transferred at cost i.e. in case of
  depreciable/amortizable assets the WDV of the
  assets or intangible, in case of stock in trade
  the fair market value and in the case of any
  other assets the transferors cost at the time of
  disposal
• In the case of restructuring where assets like
  land, building and other fixed assets are move
  from one entity to another, the assets may be
  transferred at fair market value which increases
  the overall value of the company
• It is my humble view that inspite of the
  provisions of Section 97 such revaluation can be
  done which may or may not result in the
  recognition of a goodwill. For tax purposes such
  revalued amount will be ignored and the tax WDV
  of assets that prevailed in the books of the
  transferor will be recognized in the books of the
  transferee for tax purposes
• Resultantly there will be a difference between
  the tax base and accounting base which is quiet
  normal and acceptable. Depreciation for tax
  purposes will be allowed on historical tax base
  and any goodwill that is recognized in a
  transaction of internal restructuring will not be
  recognized for tax purposes and consequently
  amortization cannot be claim on such self created
  goodwill.

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Non Recognition Rules for Restructuring
Transaction

• A new Section 97A was inserted through Finance
  Act, 2007 which primarily had all the
  characteristics that are their in Section 97.
  However, this section is far more wider in scope
  and provides much more space for restructuring.
• This section provides that no gain or loss shall
  be taken to arise on the following
• any disposal of asset from one company to another
  
• issue, cancellation, exchange or receipts of
  shares
• That takes place under a scheme of arrangement
  and reconstruction under the various provisions
  of the Companies Ordinance, 1984 or the Banking
  Companies Ordinance, 1962
• The conditions required to be fulfilled are the
  same as provided for in Section 97 except one
  more condition that the scheme of arrangement
  should be approved by High Court, SBP or SECP as
  the case may be.

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Non Recognition Rules for Restructuring
Transaction

• This section provides for more flexibility for
  restructuring for the following reasons
• there is no conditions that be companies involved
  in the reorganization be wholly owned companies,
  which is a prerequisite for Section 97
• it provides protection to any resultant gain of
  the transfer of shares among the shareholders as
  a result of restructuring of the group

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Non Recognition Rules for Restructuring
Transaction

• It should be kept in mind that under both the
  provisions of Section 97 and 97A, the basic
  principle is not to tax any gain that arises on
  the transfer of any asset or shareholding within
  the same group of person
• In both the provisions for tax purposes the value
  of the asset or share is recognized at the cost
  prior to the restructuring
• Therefore, affectively it is a deferment of the
  gain and the resultant tax exposure on such gain.
  Any subsequent sale of the asset or shares by any
  member or company to a third party would trigger
  taxation
• The gain will be calculated as the difference
  between the fair market value at the time of sale
  and the original costs recognized for tax
  purposes at the time of transfer of assets/shares
  on restructuring.

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• Thank You