“In line with the stated policy of the Narendra Modi government, the Finance Minister has reassured the people of India, multinational companies and the international investor community that India is committed to a stable and predictable tax regime and it would rather avoid making any retrospective change of tax laws,” said Sanjay Sanghvi, partner at Khaitan & Co.
Corporate tax cut
Jaitley delivered on one of the mooted direct tax reforms: a corporate tax cut.
“One of the most important announcements was the reduction in the corporate tax rate from 30% to 25% in a phased manner over the next four years,” said Sagar Wagh from EY’s India desk in London.
“Such announcement has given certainty to investors about the direction in which India is moving,” added Wagh. “However, it is disheartening that there is no immediate change in the rate for FY2015-16.”
Subhankar Sinha, senior vice president, head of tax for the South Asia region at Siemens, described the rate reduction, along with the phasing out of exemptions, as “a step in the right direction” which should lead to a more certain and less litigious tax environment.
As expected, Jaitley announced the deferral of the Indian general anti-avoidance rules (GAAR) until 2017.
Sinha described the decision to defer GAAR as a sensible step. The two year deferral – it was set to be introduced from April this year – will mean India has the chance to incorporate the final recommendations of the OECD’s BEPS project before finalising the GAAR legislation.
“Hopefully, by that time the government will have made good progress in reforming the tax administration along the lines suggested by the TARC [Tax Administration Reform Commission, led by Parthasarathi Shome],” added Sinha.
Prime Minister Modi described the Budget as “investment friendly” and said it “removes all doubts on tax issues”.
“It assures investors that we have a stable, predictable and fair tax system,” he said.
Aside from GAAR deferral, there was also clarity regarding indirect share transfers, which should further serve to reassure foreign investors that the Modi government is serious about changing perceptions.
“Several clarifications on indirect transfers will provide much-needed relief to MNCs on global deals with footprints in India, and internal restructurings,” said Sinha.
The confirmation that a single national goods and services tax (GST) will be rolled out in place of a complex raft of local duties by April 1 2016 is cause for further cheer, though not unexpected. GST should simplify collection and compliance, and the government sees the tax as playing a “transformative” role in the way the Indian economy functions.
“It will add buoyancy to our economy by developing a common Indian market and reducing the cascading effect on the cost of goods and services,” said Jaitley.
Make in India
Much of the pre-Budget murmuring centred around the likelihood of tax incentives aimed at encouraging manufacturing as part of one of the government’s flagship policies – the ‘Make in India’ campaign.
“The Indian government is finally realising that the key to the success of the ‘Make in India’ initiative is to make India an attractive destination from a tax perspective, which would entail reduction in the corporate tax rate,” said Wagh.
The campaign will drive forward in the coming months. However, despite positive changes aimed at foreign investors, there was a sense of disappointment at the lack of new measures to drive domestic demand that could stoke the manufacturing sector.
Corporate residency criteria
Another significant proposal was announced to ensure that a shell company, incorporated outside India but controlled and managed from India, does not escape taxation in the country.
“A foreign company will now be treated as resident of India and consequently taxable in India if, at any time during the year, its POEM [place of effective management] was in India, that is, its key management and commercial decisions are in substance made in India,” said Sanghvi.
The new POEM criteria aim at countering the situation in which a company could easily avoid becoming resident in India by, for example, holding a board meeting outside the country.
The lack of clarity on the terms “key management and commercial decisions” is troubling, however.
“The provision is worded in an ambiguous manner,” said Wagh. “The new provisions seem to go beyond the ‘head and brain’ principle [an alternative to central management and control] for decision-making as a criteria of effective management laid down by the House of Lords in the De Beers case.”
“The new provision would pave the way for substantial disputes and litigation,” fears Wagh. “It would be essential for companies incorporated outside India to maintain robust documentation to demonstrate that their POEM is outside India.”
Good news on PE front?
The Budget appeared to bring other good news for investors, with the confirmation that fund managers should not constitute a permanent establishment (PE) in India. A specific regime has been proposed to try and attract offshore fund managers to locate in India.
“It’s very heartening to see the use of tax policy for attracting foreign fund managers to manage their funds from India by making a specific provision in the law to insulate them from permanent establishment [status] despite being based in the country,” said Sinha.
“This is a positive move to attract fund managers to set up operations in India,” agreed Wagh, though he harboured some concerns about practicalities.
“However the provisions are accompanied by stringent conditions which may make them unworkable. Some of the conditions – like the fund manager should not be an employee of investment fund or connected person – are not practical.”
The requirement that the remuneration paid by the fund to a fund manager for its management activities should satisfy the arm’s-length test would also increase compliance costs, which may detract from the regime’s intended benefits.
“This may further lead to increase in tax disputes and thus prove counterproductive to the desired purpose,” said Wagh.
Jaitley said there is no need to revive the Direct Taxes Code (DTC) because most of the DTC provisions are by now already part of the Income Tax Act.
“Enacting a new DTC would take away the advantage of these,” said Sanghvi. “I think this is a huge positive for all stakeholders.”
More to follow…
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