Avoidance of tax and exclusion from tonnage tax scheme

234(1)

Subject to the provisions of this Part, the tonnage tax scheme shall not apply where a tonnage tax company is a party to any transaction or arrangement which amounts to an abuse of the tonnage tax scheme.

234(2)

For the purposes of sub-section (1), a transaction or arrangement shall be considered an abuse, if the entering into or the application of such transaction or arrangement results, or would but for this section have resulted, in a tax advantage being obtained for—

• (a) a person other than a tonnage tax company; or
• (b) a tonnage tax company in respect of its non-tonnage tax activities.

234(3)

In this section, “tax advantage” includes—

• (a) the determination of— (i) the allowance for any expense or interest; or (ii) any cost or expense allocated or apportioned, which has the effect of reducing the income or increasing the loss, from activities other than tonnage tax activities chargeable to tax, computed on the basis of entries made in the books of account in respect of the tax year in which the transaction was entered into; or
• (b) a transaction or arrangement which produces to the tonnage tax company more than ordinary profits which might be expected to arise from tonnage tax activities.

234(4)

Where a tonnage tax company is a party to any transaction or arrangement referred to in sub-section (1), the Assessing Officer shall, by an order in writing, exclude such company from the tonnage tax scheme.

234(5)

The Assessing Officer shall pass an order under sub-section (4), after––

• (a) giving an opportunity to the company by serving a notice calling upon such company to show cause, on a date and time to be specified in the notice, why it should not be excluded from the tonnage tax scheme; and
• (b) obtaining prior approval of the Principal Chief Commissioner or Chief Commissioner.

234(6)

The provisions of this section shall not apply where the company satisfies the Assessing Officer that the transaction or arrangement was a bona fide commercial transaction and had not been entered into for the purpose of obtaining tax advantage under this Part.

234(7)

Where an order has been passed under sub-section (4) by the Assessing Officer excluding the tonnage tax company from the tonnage tax scheme, the option for tonnage tax scheme shall cease to be in force from the first day of the tax year in which the transaction or arrangement was entered into.

Explanation

Section Summary:

Section 234 of the Income Tax Act addresses the exclusion of a tonnage tax company from the tonnage tax scheme if it engages in transactions or arrangements that are considered an abuse of the scheme. The purpose is to prevent companies from misusing the tonnage tax scheme to gain unfair tax advantages, either for themselves (in non-tonnage tax activities) or for other parties.

Key Changes:

1. Abuse of Scheme Defined: The section explicitly defines what constitutes an "abuse" of the tonnage tax scheme, focusing on transactions that result in a tax advantage for non-tonnage tax activities or for third parties.
2. Exclusion Mechanism: Introduces a formal process for the Assessing Officer to exclude a company from the tonnage tax scheme if abuse is detected.
3. Bona Fide Transactions: Provides an exception for transactions that are genuine commercial arrangements and not aimed at obtaining a tax advantage.

Practical Implications:

1. For Tonnage Tax Companies: Companies must ensure that their transactions do not artificially reduce taxable income or shift profits to non-tonnage tax activities or third parties. If found in violation, they risk being excluded from the tonnage tax scheme retroactively.
2. For Assessing Officers: They are empowered to investigate and exclude companies from the scheme, but must follow due process, including issuing a show-cause notice and obtaining prior approval from higher authorities.
3. For Compliance: Companies must maintain clear documentation to prove that transactions are bona fide and not aimed at tax avoidance.

Critical Concepts:

1. Tonnage Tax Scheme: A special tax regime for shipping companies where tax is calculated based on the tonnage of the ship rather than actual profits.
2. Tax Advantage: Includes any reduction in taxable income or increase in losses due to improper allocation of expenses, costs, or profits.
3. Bona Fide Transaction: A genuine commercial transaction entered into for legitimate business purposes, not primarily for tax benefits.

Compliance Steps:

1. Document Transactions: Maintain detailed records of all transactions, especially those involving non-tonnage tax activities or third parties.
2. Review Allocations: Ensure that expenses, costs, and profits are allocated fairly and in accordance with the tonnage tax scheme rules.
3. Respond to Notices: If served with a show-cause notice, provide evidence to demonstrate that the transaction was bona fide and not for tax advantage.
4. Monitor Compliance: Regularly review internal processes to ensure no inadvertent violations of the tonnage tax scheme rules.

Examples:

1. Scenario 1: A tonnage tax company enters into a transaction with a related party, allocating excessive expenses to its non-tonnage tax activities, thereby reducing its taxable income. This would be considered an abuse of the scheme, and the company could be excluded from the tonnage tax scheme.
2. Scenario 2: A tonnage tax company leases a ship to a third party at a rate significantly higher than market rates, resulting in inflated profits. If this is done to shift profits to the tonnage tax activities, it could be seen as an abuse, leading to exclusion from the scheme.
3. Scenario 3: A tonnage tax company enters into a genuine charter agreement with an unrelated party at market rates. If the Assessing Officer questions the transaction, the company can provide documentation to prove it is a bona fide commercial arrangement, avoiding exclusion from the scheme.