The key macro-economic takeaway of the 2019-20 budget is the government's determination to make India into a $5 trillion economy. Towards this end, a road map has been laid and measures proposed to boost the Make in India initiative and to give a push to infrastructure and rural development. On the tax front, the focus is on widening the tax base, addressing tax challenges faced by start-ups, providing targeted incentives, issuing clarifications on key provisions and improving administration.
Rationalisation of tax rates
The Finance (No. 2) Bill 2019 (the Bill) has proposed extending the beneficial tax rate of 25% to all domestic companies that had a turnover of less than INR4 billion ($58 million) in financial year (FY) 2017-18. This is an increase from the previous turnover threshold of INR2.5 billion in FY 2016-17.
The budget retains the existing 15% surcharge rate for individuals who earn over INR10 million in a financial year but less than INR20 million. However, it increased the surcharge rate for individuals, Hindu undivided families (HUFs), association of persons, body of individuals and artificial juridical persons (including non-residents) (collectively: specified taxpayers). The increase comprises a 25% surcharge rate on specified taxpayers earning more than INR20 million, but under INR50 million, which would effectively increase the tax rate to 39% for the highest slab of the specified taxpayers. It also increases the surcharge rate to 37% for specified taxpayers earning more than INR50 million, which would effectively increase the tax rate to 42.7% for the highest slab of specified taxpayers.
The proposed increased surcharge rate not only impacts high-net-worth individuals but also foreign portfolio investors (FPIs), which have been set up as trusts in their overseas resident jurisdictions. At the enactment stage of the Bill, no leeway has been provided to FPIs to exempt them from these increased surcharge rates.
Addressing angel tax woes and taxing AIFs
As it stands, and before the Bill's ratification, a closely held company is taxed (the 'angel tax') if it receives consideration for a share issuance from a resident in excess of the fair market value of the shares. An exemption from this tax is available if the consideration is received via a venture capital undertaking from a Category I Alternative Investment Fund (AIF). The Bill proposes to extend this exemption to all sub-categories of Category I AIF, such as infrastructure and social venture funds, and Category II AIFs. The central government is also empowered to exempt notified classes of companies from such taxes, subject to the fulfilment of certain conditions. Companies are now liable to be taxed in any year in which they fail to comply with such conditions.
Some other announcements were made in the budget speech in relation to the angel tax for which no corresponding proposals were included in the Bill. One such announcement was that the angel tax would not be applicable if the start-ups and their investors filed requisite declarations and provided prescribed information in their tax returns. Another was to put in place a mechanism of e-verification to establish the identity of an investor and the source of its funds. A third was that special administrative arrangements would also be made by the Central Board of Direct Taxes (CBDT) for pending assessments of start-ups and redressing grievances.
In a separate amendment that will impact Category I and Category II AIFs, the pass-through tax treatment has been extended to all losses other than business losses. Such losses will be allowable in the hands of the unit holders provided that the unit holder has held the units for a minimum of 12 months.
Incentivising the international financial services centre (IFSC)
In order to facilitate the growth of the IFSC, a series of additional tax benefits are being extended.
Under the pre-budget tax regime, non-residents were exempted from capital gains tax on transfers of global depository receipts, rupee-denominated bonds and derivatives on a stock exchange in an IFSC. The Bill proposes to extend this to the transfer of specified securities in IFSCs traded by Category III AIFs where all the unit holders are non-resident, subject to the fulfilment of specified conditions.
The interest income earned by non-residents in relation to monies lent on or after September 1 2019 to a unit located in an IFSC will be exempt.
A company operating from an IFSC and earning income solely in convertible foreign exchange is exempt from dividend distribution tax (DDT) in respect of the dividend paid out of the income earned. This exemption from DDT has now been extended for any amount distributed by a unit in an IFSC out of accumulated profits derived from operations in an IFSC after April 1 2017.
Similarly, the Bill has extended a DDT exemption in respect of income distributed, on or after September 1 2019, by a Securities and Exchange Board of India (SEBI) registered mutual fund located in an IFSC. This applies where all the unit holders are non-residents and derive income in convertible foreign currency.
The Income-tax Act of 1961 (Act) provides for a tax holiday for IFSC units by way of a 100% deduction on the profits for the first five years and a 50% deduction over the next consecutive five years. The Bill proposes to amend this to include a 100% profit-linked deduction in any continuous 10-year block within a 15-year period beginning with the year in which necessary permissions are obtained.
A broad modernising effort
The reforms will modernise and update the tax regime across a wide range of areas.
As regards transfer pricing, the pre-budget law required Indian taxpayers to realise and repatriate to India transfer pricing adjustments to any additional consideration pursuant to an advance pricing agreement (APA) or mutual agreement procedure. A failure to repatriate the additional consideration would result in a notional interest being imputed.
The reforms propose to change this to provide for an optional one-time tax payment in lieu of the notional interest in perpetuity. Such a tax is applicable at 18% plus a 12% surcharge. The tax due will be a final tax payment and neither corresponding tax credits, nor any deductions will be allowed in respect of the amount on which such additional tax is paid.
The secondary adjustment provisions will only apply if the primary adjustment exceeds INR10 million and if it pertains to FY 2016-17 or later.
As regards the maintenance of the master file, the Bill plans to expand its scope to include to a constituent entity in India even when the constituent entity does not undertake any international transaction. For the purposes of filing a country-by-country report, the Bill stipulates that the accounting year for an alternate reporting entity resident in India will be aligned with that of the ultimate parent entity.
Additionally, the reforms propose to expand the scope of the 'source rule'. Certain taxpayers were taking a view that gifts made by resident persons to persons outside India were not taxable in India because the income does not accrue or arise in India. To ensure that such gifts are taxable in India, the Bill aims to expand the scope of the 'source rule' so as to tax any sum of money paid on or after July 5 2019, without consideration by a resident to a person outside India.
The Bill also strives to promote the cashless economy. With a view to encouraging non-cash transactions by businesses, the Bill envisages a tax deduction at source at a 2% rate for withdrawals of more than INR10 million in any financial year. The tax will be deducted by banks at 2% on cash withdrawals from one or more accounts with the same bank that exceed INR10 million per year.
Separately, the reforms propose that a person with a business with sales, turnover or gross receipts in excess of INR500 million during the preceding year will be required to provide a facility for accepting payments through prescribed electronic modes. A penalty of INR5,000 per day will be levied where there is a failure to provide such a facility for electronic modes of payment.
In parallel, the Bill will amend the Payments and Settlement Systems Act 2007, to be amended to prohibit banks from imposing any charges on anyone (either directly or indirectly) for using electronic methods of payment. In other words, the savings in cost that will accrue to the banks on account of lesser cash handling will be used to absorb the incremental costs of handling digital payments.
Tax audit and procedural changes
With a view to improving the accuracy and cutting the time taken to prepare annual tax returns, the Finance Bill proposes to make pre-filled tax returns available to taxpayers containing details of certain income streams for which information will be sourced from banks, stock exchanges, mutual funds and other institutions.
With a view to simplifying the procedure through which taxpayers can claim refunds, the Bill proposes that a claim for a refund can be made only by furnishing a return of income.
The Bill also proposes that few more categories of taxpayers will be mandatorily required to file tax returns if, during the previous year, either: expenditure incurred on foreign travel surpasses INR200,000; electricity expenditure exceeds INR100,000; deposits in a current account exceed INR10 million; or any other of the prescribed conditions are satisfied.
The reforms also plan to introduce a new scheme of electronic assessment involving no human interface. Such e-assessments will be undertaken in cases that requirie verification of certain specified transactions or discrepancies.
Changes to anti-abuse provisions are also foreseen. Under the pre-Bill rules, buy-back tax was levied only on share buy-backs by an unlisted company. With effect from July 5 2019, share buy-backs by any domestic company (listed or unlisted) will be subject to a buy-back tax of 20% (plus surcharge and cess). Consequently, income arising on buy-backs will be exempt in the hands of shareholders.
A tantalising incentive for investors
In the budget speech, the Finance Minister proposed investment-linked income tax deductions for mega-manufacturing plants set up in sunrise and advanced technology areas. This would impact semi-conductor fabrication (FAB) activities as well as businesses manufacturing photovoltaic cells, lithium storage batteries, solar electric charging infrastructure, computer servers and laptops. However, the Bill does not carry any amendments towards this end, so investors will have to wait and see if the intent ever sees the light of the day.
Dinesh Kanabar has, over the decades, been recognised by his peers as among the top tax advisors in India. His ability to relate the business strategies of clients to the tax and regulatory environment has been recognised as unique and he has played a critical role in evolving solutions for clients.
Prior to founding Dhruva, Dinesh held a series of leadership positions across several large professional service organisations in India. He has been deputy CEO of KPMG India; Chairman of KPMG's tax practice; Deputy CEO of RSM & Co; and he subsequently led the tax and regulatory practice of PricewaterhouseCoopers (PwC) upon the merger of RSM & Co with PwC.
He is a member of the national committee of The Federation of Indian Chambers of Commerce and Industry (FICCI). He has worked with the government on several policy committees. He was a member of the Rangachary Committee constituted by the Prime Minister of India to deal with tax reforms in the IT/ITES sector and for evolving safe harbour rules.
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Rishi Kapadia is a chartered accountant with more than 13 years' experience in the field of corporate taxation. He has significant experience in advising MNCs and domestic companies on various aspects of domestic and cross-border taxation, inbound investment and entry strategies, cross-border leasing and special economic zones.
He also has vast experience representing clients before tax authorities. He has worked across industry sectors such as infrastructure, oil & gas, manufacturing and FMCG, pharmaceuticals and IT/ITeS, among others.
Rishi has worked with EY and PwC and was a director with KPMG's tax practice before joining Dhruva.