India’s budget announcement for 2024 underscores the government’s commitment to simplifying the income tax regime, and it also unveiled a series of pivotal reforms aimed at bolstering India’s economic growth.
This article delves into the major proposals of the budget aimed at transforming the Indian tax regime.
Capital gains tax overhaul and reducing tax for foreign corporates
The general corporate tax rate for foreign companies (applicable to ordinary income and business income attributable to a taxable presence in India) is proposed to be reduced from 40% to 35%. Further, the government has proposed a uniform tax rate of 12.5% on long-term capital gains, irrespective of the asset class and the type of investor (resident or non-resident), and the removal of the cost indexation benefit.
As a result, for non-residents, tax on long term gains on:
Shares has increased from 10% to 12.5%; whereas
Certain other securities and assets has reduced from 20% to 12.5%.
It is also proposed that gains on unlisted debt securities (such as debentures) would be deemed as ordinary income, regardless of the holding period, resulting in a higher tax rate of 35% instead of the 10% or 20% rates applicable currently. Domestic tax rates are subject to additional surcharge and cess which remain the same and therefore, the effective tax cost in India would include such additional levies.
Further, provisions for the determination of capital gains as either long or short-term have been streamlined. Going forward, only two holding periods are proposed: 12 months for listed securities and 24 months for other assets.
While the revamped capital gains taxation regime may be beneficial or adversarial depending on the asset involved, it would be much simpler compared to the currently applicable tax rates and holding period thresholds, which vary depending on the assets and the taxpayer’s residential status.
Revamping buyback tax
Currently, domestic companies repurchasing their shares are subject to a 20% tax on the net distributable income, and the income received by shareholders is exempt.
Buyback tax is similar to the dividend distribution tax (DDT) which was applicable until March 2020. DDT was payable as an additional tax by the companies on distributed dividends and there was no tax payable by the shareholders. Effective April 2020, dividends are taxable in the hands of the shareholders.
The budget proposes abolishing the buyback tax starting October 1 2024, shifting the tax liability from the company to the shareholders, and buyback proceeds would be deemed as dividend income of the shareholders.
This is a significant change requiring shareholders to pay tax on buyback proceeds as ordinary income. The cost basis in shares will be treated as a capital loss eligible to be set off or carried forward for set off in the subsequent years against the taxable capital gains.
Non-resident shareholders should be able to benefit from a lower rate under tax treaties which generally cap the tax rate on dividends at 10% to 15%, and they should be able to claim credit of Indian taxes in their home jurisdiction. These benefits are not available under the current regime as buyback tax is a tax on Indian companies.
For relying on treaty benefits, demonstrating eligibility for tax treaty entitlement and 'beneficial ownership' of income would be key factors, which will entail specific analysis.
For non-residents, this change is expected to reduce the high economical tax cost previously faced, thereby enhancing the overall investment returns.
India's step towards the OECD's two-pillar solution
Introduced in 2020, Equalisation Levy 2.0 (EL) is a 2% tax on revenue generated by non-resident e-commerce operators from the sale of goods and services in India.
The levy aimed to tax digital businesses that had a significant market in India without a physical presence, but led to practical challenges due to its broad scope and ambiguities.
EL is levied under a separate code which is not subject to the beneficial provisions of tax treaties. This led to challenges in claiming credit of EL in home jurisdictions and the additional cost of doing business in India.
In a significant and a welcome move, the Indian government has proposed abolishing EL effective from August 1, 2024. The withdrawal of EL is expected to reduce compliance burdens and litigation for non-residents given its wide ambit.
This decision aligns with India's commitment to the OECD’s two-pillar solution, which aims to establish a global consensus on taxing the digital economy. A unilateral measure like EL was not seen favorably in light of such developments.
Abolishing EL is indeed a preparatory measure to integrate the two-pillar approach into Indian domestic tax laws. As indicated in the post-budget press conference, amendments to domestic legislation to integrate two pillar solution are expected shortly.
Angel tax abolished
The angel tax, introduced in 2012, was designed to curb the circulation of unaccounted money through the infusion of share capital at inflated share premiums. Initially applicable only to resident investors, the Finance Act 2023 extended its scope to include non-resident investors, impacting the start-up ecosystem’s capacity to leverage foreign investments.
Recognising the adverse impact on start-ups, the government has proposed to abolish the angel tax. This should provide much-needed relief and flexibility to investors and target entities, without having to address a multitude of valuation and structuring issues to avoid the applicability of angel tax in genuine fund-raising rounds driven largely by commercial considerations, and not tax avoidance.
It also mitigates the risk of litigation concerning issues relating to the valuation methodology adopted by taxpayers, and the accuracy of the assumptions involved in these valuations. This measure is expected to revitalise the funding landscape for Indian start-ups, thereby fostering innovation and entrepreneurship.
Corporate gift tax exemption removed
Currently, transfers by way of a gift are exempt from tax for the transferors. Law does not prescribe the condition of natural love and affection for a gift to be valid. This means that gifts involving corporates should also be recognised as valid and tax exempt.
However, gifts by corporates are generally frowned upon, leading to tax disputes. It is now proposed to restrict the tax exemption to gifts made by individuals only. This change aims to close this loophole, ensure a more equitable tax system and provide certainty.
In practice, gifts by corporates are generally evaluated as possible modes to achieve internal group restructuring. Companies will now need to explore alternative approaches to comply with the new tax regulations.
Budget 2024 introduces a suite of reforms for fairer tax practices that are poised to stimulate economic growth, attract foreign investment, and strengthen India's position as a global economic hub.
The Finance Minister has also announced a comprehensive, time-bound review of the existing provisions of the Income Tax Act 1961 during this year, and this should be keenly tracked by stakeholders.
The views of the author(s) in this article are personal and do not constitute legal/professional advice from Khaitan & Co.
