India: Indian budget 2018-19; Recent rulings on the India-Mauritius treaty

The Indian budget was presented on February 1 2018.

Indian budget 2018-19

The Indian budget was presented on February 1 2018. Some important tax changes proposed in the budget are summarised below.

Widened scope of 'business connection'

Under the prevailing Income-tax Act, 1961, a non-resident is taxable in India in respect of his income from a 'business connection' in India. The concept of a business connection is thus the domestic law equivalent of the permanent establishment (PE) concept under tax treaties and has been part of the law for several decades now. This term is not exhaustively defined, but it is deemed to include certain activities undertaken by an agent.

The budget proposes to align the scope of the business connection in respect of agents with the modified dependent agent PE definition under the multilateral instrument. As a result, the term 'business connection' will also include any business activities carried out through a person who, acting on behalf of the non-resident, habitually plays the principal role leading to conclusion of contracts by the non-resident. No exclusion is available for activities limited to the purchase of goods.

More importantly, it proposes to expand the scope of the business connection to include 'significant economic presence', which is defined to mean:

Transactions in respect of any goods, services or property carried out by a non-resident in India, including the downloading of data or software in excess of an amount to be prescribed; and
The systematic and continuous soliciting of business activities or engaging in interaction with users (number to be prescribed) in India through digital means.

This is an important change and could potentially lead to digital businesses having a taxable presence in India. However, this does not override India's tax treaties and, hence, non-residents who are entitled to treaty benefits will continue to be governed by the PE definition in the treaty.

Taxation of capital gains arising on transfer of shares of listed securities

Long-term capital gains (LTCG) arising on the transfer of listed equity shares are exempt in the hands of the transferor if a securities transaction tax (STT) has been paid. It has been proposed that this exemption is removed, and that LTCG in excess of INR 100,000 ($1,600) will be subject to tax at a 10% rate (plus surcharge and cess). Notional gains accrued up to January 31 2018 are grandfathered.

Recent rulings on the India-Mauritius treaty

The Authority for Advance Rulings (AAR) recently issued two rulings on the availability of the capital gains exemption in India under the India-Mauritius tax treaty. In both cases, the Mauritius shareholder had sold its shares in an Indian company to a Singapore company.

The AAR upheld the availability of treaty benefits in one case (AAR No. 1128 of 2011) but denied it in the other (AAR No. 1129 of 2011). This was on account of factual differences between the two cases on the issue of whether the Mauritius shareholder was acting on its own behalf, and whether the shares of the Indian company that were transferred by the Mauritius shareholder actually belonged to it.

The key factors that differentiated the two cases were that in the case where the treaty benefit has been extended, the AAR found that the Mauritius company had:

Acted as an independent company, taking its own decisions;
Made investments in the Indian company out of its own funds through banking channels; and
Signed proper agreements for the acquisition of shares of the Indian company thus indicating that it was the 'real owner' of the shares.

The AAR also noted that, except in extraordinary and exceptional circumstances where the above factors are not met, the benefits under the treaty would not be denied.

These rulings highlight the importance of documentation and conduct in successfully availing treaty benefits. Specifically, in addition to obtaining a tax residency certificate, it is necessary to demonstrate independent decision-making and appropriate documentation in relation to investment in Indian assets.