In finance parlance, bonds refer to loan instruments. The issuers – central government, various state governments and companies – can raise funds by issuing bonds of varying maturities to finance investments in various projects. The issuers (borrowers) pay interest periodically to the subscribers (lenders) of the bond as per the debt covenant. Upon maturity, the principal amount originally raised is refunded to the subscribers. Normal bonds create a debtor-creditor relationship.
Under the electoral bonds (EB) scheme introduced in 2017, bonds of different denominations ranging from Rs 1,000 to Rs 1 crore could be purchased by entities from the State Bank of India (SBI), and then handed over to the political parties anonymously. The political parties were required to encash the bonds within 15 calendar days.
The scheme did not require any disclosure of the names of the entities to any authority including the Election Commission. The transactions between the companies and political parties created a pure anonymous donor and donee arrangement (not a relationship, because in a relation one knows the identity of the counter party) using the SBI as a conduit. The term ‘bond’ is clearly a ‘deceptive’ nomenclature given the context as the arrangement does not create a debtor-creditor relationship at all.
Let us now delve deeper into the Income Tax (I-T) aspects of the arrangement. Prior to introduction of the EB scheme, a company could give donations to the political parties, directly or through electoral trust, subject to a maximum amount of 7.5% of the average net profit earned by the company over the last three financial years. The donation made was eligible for deduction in computing taxable income of the company. Thus, the eligibility criteria for claiming deduction under the I-T Act were:
- The companies must be profitable in the sense that average profit of the last 3 financial years of a company must be positive. If the average profit of last three financial years is negative (that is, loss) the company would not be able to make any donation to any political party in the fourth year.
- Even in case the average profit in the last 3 financial years is positive, the maximum amount of contribution was capped at 7.5% of the average profit.
Also read: Seven Points That Merit Investigations: The Electoral Bonds Saga Isn’t Over with Data Spilling Out
Upon the introduction of the electoral bond scheme in 2017, the cap on contribution to the political parties were removed by amending the Companies Act. The amendment enabled even loss making companies to donate to political parties without any limit.
When the names of the companies making donation through EBs were disclosed by the order of the Supreme Court, it was observed that a number of loss making companies purchased bonds. For a loss making company, there is no income tax benefit for making such contribution through EBs, so why were such contributions made?
This strengthens the suspicion of extortion and quid pro quo raised during the arguments in the Supreme Court. According to Reporter’s Collective, there are at least 16 loss making companies that purchased EBs and 31 companies purchased EBs worth more than the average profit of the last three financial years. Even for the loss making companies, there is a possibility of getting substantial benefit under the I-T Act through purchase of EBs causing loss to the exchequer.
For instance, company X has a revenue of Rs 1,00,000, total cost (other than depreciation) is Rs 1,50,000 and the depreciation is Rs 20,000. The company purchases EBs worth Rs 40,000. Hence, profit earned before EB purchase= 100-150-20 = – 70,000 (that is, loss). Hence, there is no income tax benefit of the EB purchase in the financial year in which the EB is purchased. However, the loss has two components: Rs 50,000 attributable to costs other than depreciation and Rs 20,000 for depreciation. The first component can be carried forward and set off against the future profit up to 8 financial years, and the second can be carried forward indefinitely.
Therefore, if a loss making company gets any contract or deal through quid pro quo, even the profit that would be made therefrom shall not attract tax liability, because their loss would be set off against the future profit.
As a result, the burden of financing the public expenditure will be shifted to the future generation through higher tax because of of tax saving by a few. In fact, if a contribution is made through EB purchase by a hugely loss making entity, tax shield (saving) might exceed the amount of EB purchase in select cases. The benefit is a bonanza for cronies, a dent for the exchequer and a tax burden for the future generation.
S.K. Ganguli is a professor of finance of Jaipuria Institute of Management, Noida (NCR). He can be reached at skganguli@rediffmail.com.
