Conclusion Papers

Wednesday March 18, 2020

Post Budget Review

THE 2020-21 UNION BUDGET: AN ASSESSMENT

Speaker: Daksha Baxi, Head of the International Tax Practice at Cyril Amarchand Mangaldas

In India, writing a Budget that satisfies everyone is a nigh impossible task. Conditions vary so much across the country – from utter destitution to pockets of 21st-century affluence – that it becomes difficult to achieve growth that is both rapid and inclusive. Expectations were rife that the 2020-21 Budget would deliver both a demand-side stimulus and big-bang reforms. Ultimately, it ended up disappointing many. In terms of stimulus, its impact is likely to prove modest. However, there were some important announcements around agriculture; a new Investment Clearance Cell; some sops for manufacturing and electronics assembly lines; a big push on disinvestment; and further steps on PPPs and Smart Cities. However, most of the real ‘action’ was in the area of taxation, and here, the ‘hits’ seem to outweigh the misses. At a recent Forum session in Pune, Daksha Baxi, who heads the International Tax Practice at Cyril Amarchand Mangaldas, highlighted the key takeaways.

SEVERAL HITS…

A bold new ‘taxpayer charter’ will aim to ease the mistrust between the Department and taxpayers

A proposed ‘taxpayer charter’, which aims to foster trust between the Department and tax-payers, is bold and path-breaking. Only three other countries – the US, the UK and Australia – currently have such a charter. Given the present state of affairs where mistrust and litigation are rampant, it is hard to anticipate how this might play out but it would seem to be a step forward in terms of respecting and appreciating taxpayers’ rights. Complementing this, the government will make efforts to further modernise the litigation process, including with electronic appeals.

The abolition of the DDT will make some individuals unhappy, but on the whole is a big positive

Another measure is the abolition of the Dividend Distribution Tax (DDT). Going forward, all dividends will be taxed in the hands of shareholders. Individuals who hold large blocks of shares in their companies will be unhappy about this but at the macro level, it is a positive move. It will simplify the income tax rules, given that currently, at least 20-25 sections of the Act are linked to the DDT. For instance, investee companies such as REITs will no longer be double-taxed. Crucially, foreign investors with dividend earnings will be taxed at the rates applicable to foreign non-residents in line with treaty provisions – some of which entail rates of 10% or less. Moreover, earlier, such investors would not have been able to claim tax credit for the outgo under DDT. Effectively, this will make equity investments into India cheaper for foreigners. It will also obviate the need to enter into creative tax structures that side-step the DDT and then result in transfer pricing litigation.

A hike in the threshold limit for start-ups, and easier norms for tax on ESOPS

Start-ups have been given a boost with the turnover threshold being raised from Rs 250 million to Rs 1 billion. Further, given their long gestation period, tax holidays can now be claimed in 3 of the first 10 years of a start-up’s operations, up from 3 of the first 7 years. To help start-ups attract and retain talent, employees can now defer the tax payable on ESOPs that they exercise by 48 months, or – if the person leaves the company – at the time they sell their stock.

An expanded safe harbour for real estate

The beleaguered real-estate sector will gain from an expanded safe harbour for property transactions. With many sales taking place at values below that indicated by the applicable stamp duty, the government last year allowed for a 5% deviation for capital-gains tax calculations. This has now been increased to 10%.

Easier norms around having an India-resident fund manager will attract more global funds to the country

Offshore funds will gain from certain budgetary provisions. India has long sought to ensure that such funds have an India-resident fund manager. The problem is that appointing such a manager automatically deems the fund to have a business connection or permanent establishment (PE) in India, subjecting its global income to tax in India and nullifying any treaty benefits it might enjoy in terms of capital-gains or dividend-withholding tax. To avoid this, the laws provided for two conditions under which a fund would not be considered to have either a business connection or PE status in India. However, these criteria – which relate to the size of the fund’s initial investment in India and the time period in which this is to happen – were unduly restrictive. Both criteria have now been eased, which should help attract global funds.

A tax holiday for SWF investments in infrastructure, and more generous tax pass-through for INVITs

Infrastructure investments have also been incentivised:

  • So far, only listed infrastructure investment trusts (INVITs) were given pass-through tax status but, in line with SEBI regulations, this has now been extended to unlisted trusts.
  • Debt and equity investments by sovereign wealth funds in specified types of infrastructure have been made exempt from tax, including capital gains tax, provided they make such investments by March 31, 2024 and lock-in those investments for at least 3 years. However, investments by such funds in an INVIT do not qualify, because INVITs are not directly engaged in infrastructure development.

Lower withholding rates for investments in several debt instruments

External debt will receive a fillip. The validity of a concessional 5% withholding rate on interest payments on FPI (foreign portfolio investor) and QFI (qualified foreign investor) investments in Rupee-denominated corporate bonds and government securities has been extended from July 2020 to July 2023. Moreover, this has been made applicable to municipal bonds that are payable after July 1, 2020, but before July 1, 2023. Finally, bonds listed on an IFSC exchange will be subject to an even-lower, 4% withholding rate.

A number of ‘plumbing’ issues around international taxation have been eased

On the international taxation side, there are several changes that will, on net, be beneficial:

  • The attribution of income to PEs – a perennial subject of litigation – is being brought under the provisions of the Advanced Pricing and Transfer Pricing agreements, making it easier to attribute such income.
  • Some clarificatory changes have been made with regard to FPIs, in line with recent changes initiated by SEBI. Subject to certain conditions related to FATF (Financial Action Task Force) compliance, some categories of FPIs will not be subject to the so-called ‘Vodafone tax’. But investments routed through tax havens such as Mauritius or the Cayman Islands – which are not FATF-compliant – may face issues.
  • The government was expected to operationalise new rules around income attributable to those with a significant economic presence in India. (These have already been incorporated in the Income Tax Act but have not been made operational.) However, with the OECD expected to release a report on the subject by December, India has postponed this move and will aim to align itself with the global norms.

Not-for-profits will have to bear a bigger compliance burden

The Budget contains several provisions related to not-for-profits, who will, in general, have to contend with a stiffer compliance burden. Given that many foundations have misused the tax laws over the years, the government believes this was unavoidable. Specifically:

  • To claim exemptions, charitable organisations will need to re-register with the Income Tax Department, though this process has now been made electronic.
  • Provisional registration will be valid for three years – but automatic renewals should become a reality in time.
  • Educational institutions would previously claim exemptions under various sections of the Act, falling back on whatever provisions they could. This created enormous complexity and litigation. Going forward, this area will be streamlined, with all educational institutions being eligible for only one common type of tax exemption.

Stricter rules for residency in terms of taxing non-resident Indians…

…but relief to those who are non-resident everywhere

India’s residency rules have also been tweaked to prevent their misuse. From an original 60 days a year, the time limit for staying in India without being counted as an Indian resident for tax purposes was raised, a few years ago, to 182 days. The intent was to allow Indian-origin people to make investments or spend time with their families. However, many people misused this provision, and the limit has been cut back to 120 days a year. Simultaneously, one very contentious rule has been corrected. Until now, any Indian citizen who was ‘non-resident’ everywhere in the world but paid tax nowhere, was deemed to be an Indian resident and liable to pay tax in India on their worldwide income. This created major issues for those living in the Middle East or other tax havens, where they were ineligible for residency or citizenship even if they had bonafide jobs. Such people have now been exempted from tax in India.

An opportunity to settle tax disputes relatively cheaply

Under the proposed ‘Vivad Se Vishwas’ scheme, a taxpayer can pay only the amount of the disputed tax, with a complete waiver of interest and penalty, provided that the payment is made by March 31, 2020. The scheme will remain open until the 30th of June, and some interest will accrue on late payments. For many companies, this represents an opportunity. It will allow them to settle disputes that are unlikely to go their way, at a reduced cost.

Some beneficial tweaks to tax rates and rules

A few other tax-related changes deserve mention:

  • The reduced corporate tax rate of 15% for manufacturing companies introduced in October 2019 will, from April 2020, be made available to power generation companies.
  • Cooperative societies can now pay a 22% rate of tax instead of 30%, provided that they do not claim any deductions. They will also not be subject to MAT.
  • Social security contributions made by employers were previously tax-exempt for the employee to the extent of a certain percentage of the person’s salary. This discriminated against low-income earners, and it has therefore been replaced with an absolute upper-limit.

…AND A FEW MISSES

Some rue that the new tax slabs come with riders…

…and HNIs are under an even closer scanner

There was some disappointment that the benefits of the revised personal-income tax slabs are only available to those who give up other deductions. Few people earning over Rs 15 lacs a year are likely to switch to the new regime, though it may benefit those who earn less than that amount. It will also ease compliance for such people. At the same time, high net-worth individuals have been placed under the scanner like never before. Moreover, for both individuals and corporations, the source rule has been expanded significantly in terms of what gets taxed in India.

New TDS/TCS provisions will increase the compliance burden

Several new TDS/TCS provisions have been introduced, raising the compliance burden on individuals and small firms. For instance, TCS will now be collected on all remittances under the LRS in excess of Rs 7 lacs, and on high-value foreign tour packages. However, these amounts are creditable against a person’s income-tax dues and therefore do not raise the overall tax liability. To help deepen the tax net, e-Commerce operators will be required to withhold 1% on the gross amount of sales/services where a resident seller provides a PAN/Aadhar number, and 5% otherwise.

  1. The contents of this paper are based on discussions of The India CEO and India CFO Forums in Pune with Daksha Baxi, Head of the International Tax Practice at Cyril Amarchand Mangaldas, in February 2020. The views expressed may not be those of IMA India. Please visit www.ima-india.com to view current papers and our full archive of content in the IMA members’ Knowledge Centre. IMA Forum members have personalised website access codes.