Union Budget 2018 - Transfer Pricing: What to expect?

The year 2017 witnessed a rapid movement of the OECD-G20 BEPS project to the implementation phase, leaving a fundamentally changed landscape in its wake. Since the release of all the key instruments for BEPS implementation in Oct 2015 by the OECD, countries have legislated or have provided more clarity on how they will implement BEPS measures so that businesses have sufficient information to take stock and set a course to move forward. Across the globe, new and sometimes highly novel national legislation was released to address BEPS challenges. The impact of BEPS recommendations was seen in the 2016 and 2017 Union Budgets with the introduction of Equalisation Levy to tax digital transactions, increased transparency through country-by-country reporting and master file,  introduction of a patent box regime based on the nexus approach and interest limitation rules in line with Action 4. However, there is still some unfinished agenda arising from recent legislative changes which the Finance Minister may need to address when he presents the 2018 Union Budget.

Perceived abuse of the arms-length standard was at the heart of the BEPS initiative. That has been tackled through changes to the OECD TP Guidelines released in 2017. The changes made to the OECD TP Guidelines pursuant to BEPS Actions 8-10 largely aligns with India's view of allocating profits in line with value creation. The changes to the OECD TP Guidelines can be expected to have effect even without legislative changes because of the “soft law” status of the guidelines. Nevertheless, given the extensive changes to the OECD TP guidelines as a result of Actions 8-10, the Government should consider modifying the TP rules to reflect the revised and updated OECD guidance.

Provisions relating to secondary adjustment was introduced in the transfer pricing law by the 2017 Union Budget.  While as a concept, secondary adjustment is a globally accepted principle, it does pose certain challenges in the Indian context.  Repatriation of the amount on account of TP adjustment back into India may not really benefit the Indian taxpayer if these amounts are not required for expansion in India. The Government should consider suitable modifications to the secondary adjustment provision to address the following: (1) protecting Advance Pricing Agreements (APAs) that were signed prior to the introduction of the provision; (2) an option to remit or not to remit the amount of primary transaction should be provided to the taxpayer. In case where taxpayer opts not to remit, the amount may be treated as a “constructive dividend”.

It is acknowledged that denying a deduction for “excessive” interest expense is consistent with international norms.  However, given that India is primarily an inbound economy, the tax policies should support India's growth agenda. For many MNCs entering India, the preferred route is to use lending from overseas.  In such an environment, the introduction of interest limitation rules is likely to adversely impact many subsidiaries of MNCs that operate in India and have huge capital requirement e.g. in the infrastructure sector. Hence, suitable modifications may be considered to provide for: (1) in line with OECD's suggestion, in addition to using a fixed ratio rule a group ratio rule may be introduced. This would allow due consideration for companies that have high interest cost due to the nature of their business and also avoid double taxation on account of the artificial ceiling on the interest expense that would be allowed as deductible; (2) the law should exclude the reference to implicit guarantee, since it not possible to prove or disprove implicit guarantee; (3) exemption from the application of the provision may be extended to sectors such as NBFS and infrastructure.

Transfer pricing provisions were introduced in the tax law in 2001 to prevent the erosion of tax base of the country. There are many cases where Indian taxpayers may receive loans, services or have arrangements for use of intangibles from overseas associated enterprises (AEs), with respect to which, the overseas AEs may charge a consideration which may be less than arm's length price. Now, any receipt of interest, fees or royalty on such loans, services and licenses respectively, would attract income tax in the hands of the overseas AEs in India at 10% under the Act and/ or tax treaties, where the overseas AEs do not have permanent establishments in India. On the other hand, payments of such considerations would obtain tax deduction in the hands of the Indian taxpayer at30%. Thus, the Indian taxpayers, by paying consideration less than the arm's length price, the Indian exchequer would have only benefitted in the form of tax savings @ 20% thereof. However, a decision by the Special Bench of the Income-tax Appellate Tribunal may result in a TP adjustment in the hands of the overseas AE. In order to prevent the unintended application of the TP provisions of India in the manner, the Government could consider introducing a legislative amendment to clarify that the no upward TP adjustment may be made in the hands of foreign companies in India in such situations.

Currently, the time limitation for concluding assessments does not consider keeping TP assessment/audit in abeyance until the signing of APA for the APA covered period or for the roll back period. This results in administrative inconvenience for taxpayers to simultaneously go through audit proceedings in spite of having opted for an APA. Since APA is a mechanism to negotiate the arm's length pricing of inter-company transactions, the participation of both the parties in such discussion would essentially take time. Hence, not extending the time limit for audits where APA proceedings are pending would effectively require taxpayers to go through normal audit proceedings for the APA covered years as well as the roll back years. This may not be in line with the objective of APA program. Hence, the law may suitably be amended so as to keep transfer pricing assessment/audit under abeyance until the signing of APA, including for the roll back years, if applicable. Similarly in case matters are pending under Mutual Agreement Procedure (MAP), the law may be amended to permit the taxpayer to keep the appeal proceedings under domestic tax law in abeyance and pursue MAP. In the absence of such a provision, taxpayers (as well as the tax authorities) run the risk of the appeal proceedings concluding on the matter ahead of the MAP, thereby making the latter proceedings infructuous. Additionally, the APA roll back provisions may be amended to enable roll back for all the open years instead of limiting the same to a maximum of four year. These changes would go a long way in improving the mechanisms for dispute resolution.

The above discussed transfer pricing law related proposals would be far reaching if implemented in the Union Budget 2018 and would go a long way in improving the investment climate in India.

Union Budget 2018 - What does the FM's budget briefcase have in store?

Expectations from budgets are forever abundant, with the wish list running into boundless pages. Headlines such as “For Budget 2018, FM skips World Economic Forum 2018 summit at Davos” and “Budget may not have any freebies or sops for aam aadmi, hints PM” only leave a common man gasping with bated breath - adding butterflies to one's stomach. Will the perpetual hope that the Hon'ble FM will provide some cheer to the common man become a reality? Will this Budget have widely expected tax sops? Well, only time shall tell.  

Post implementation of the biggest tax reform since independence ('GST'), the Government has already expressed its intentions to revamp the country's direct tax system, by constituting a special task force. 

Moreover, this being the current Government's last full-fledged budget before the next year's General Elections, the FM has his task cut out to tackle an array of issues. If rumours are to be believed, the coming Budget will be Mr Jaitley's most populist one yet.  

In this background, here are some of my hopes for the D-day:

• Rejigging of tax slabs and exemption thresholds:

With the ever-so increasing prices and our tax structure not being in sync with inflation, there is a need to provide relief in the form of enhancement of basic exemption limit along with realignment of existing slab rates.

Currently, the threshold for exempt income is set at Rs 2.5 lakhs. The Government may raise this limit to Rs 3 lakhs. This expectation needs to be balanced with the fact that the number of tax payers and return filers are very low in India presently and hence there may be some continued tax filing requirement for people with gross taxable income above Rs 2.5 lakhs.

Also, fiscal situation permitting, the Government could lower tax rate to 10% on income between Rs 5 to10 lakhs, levy 20% rate for income between Rs 10 to 20 lakhs and 30% for income beyond Rs 20 lakhs. At present, income between Rs 10 to 20 lakhs is taxed at 30%.  This will be hugely popular with the middle class, which will play a critical role in the 2019 elections.

• Bringing back Standard deduction for the salaried class:

A lot of hue and cry has been made by the salaried class (the 'most' tax compliant of the lot) over years around how it is obligated to pay taxes at gross level, whereas others pay taxes after deduction of expenses. To overcome this prejudice, there would be no harm in revisiting old wisdom and reinstating the obliterated provision of 'standard deduction' for the salaried class. 

This would not only provide a soothing balm and bring a cheer to the faces of the salaried janta, it would also go out as a goodwill gesture on the Government's part - having regard to the general perception amongst this section of taxpayers, as to how neglected they are when it comes to the tax benefits granted by the Government.

• Hiking tax-free limit of Medical reimbursement:

Despite the sky rocketing medical costs, the various Governments have till date stuck to the archaic limit of Rs 15,000 towards medical reimbursement. It should be the endeavour of the FM to raise this exemption to a minimum of Rs 50,000.

• Augmentation of LTA Benefits:

Currently, exemption is allowed for employees on the amount they spend on their cost of travel within India. This benefit can only be availed twice in a block of four calendar years. Such exemption should be granted every year to boost the country's tourism and calendar year methodology should be changed to financial year. 

The wish list here also includes extending this benefit to overseas travel and accommodation expenses, however, so many goodies may not be rolled out on this front.

• Modification of the exemption limits of various allowances: 

The exemption limits of allowances like children education (Rs 100 pm) and hostel expenditure (Rs 300 pm) have become obsolete and desperately crave for the Government's attention.

Furthermore, the leave encashment exemption limit of Rs 3 lakhs (notified back in 1998) for tax calculation should be raised to Rs 10 lakhs. This comes against the backdrop of the proposed hike in tax-free gratuity to Rs 20 lakhs.

• Measures to make NPS even more attractive:

In the past, the FM has brought in partial tax exemption for NPS but this product has not been a hit with the retail investors. This is primarily because of the taxation of at least 20% of the corpus at the withdrawal stage. Besides, a major chunk needs to be mandatorily parked in an annuity. 

In order to make NPS more attractive, the FM could raise the tax exemption limit to 60% from the present 40% at the maturity stage, thereby making the entire corpus tax exempt.

This would also bring in better parity between the different retirement benefit schemes.

• Set-off of losses from house property:

In the previous Budget, the FM had curbed the set-off of house property loss against various heads to Rs 2 lakhs in a year. This dissuaded a lot of people from buying a second home. 

Keeping the spiralling real estate costs and the consequent interest cost in mind, the set-off limit should be raised to Rs 3/3.5 lakhs, to provide a much needed impetus to the sluggish realty sector.

On a related note, presently the pre-construction interest is deductible in 5 equal instalments from the year in which construction is completed. With a view to enable a buyer to reap maximum benefits, the Government should consider allowing such interest as deduction in the year(s) when the interest is paid during the property's construction or provide an added deduction for such interest post construction of property (ie without capping it to Rs 2 Lakhs).

Additionally, the provisions related to deemed to be let-out property need to be revisited, in line with the real income theory.

• Raise the maximum threshold of deduction under section 80C and section 80E:

Budget 2014 increased the section 80C deduction from Rs 1 lakh to Rs 1.5 lakhs and this limit has remained stagnant since then.

Due to the not so significant existent upper cap, various investment schemes have lost their sheen. Raising this limit will boost savings and foster investments by people. 

Another vital expenditure is the interest cost incurred for higher education, which has exponentially risen over years. Time has come to extend the window of deduction period on education loan beyond 8 years. Akin to a home loan, it should be available for the full tenure of the loan. 

• Allow LTCG exemption on equities to continue:

One of the buzzes in the run-up to the Budget is taxing LTCG from equity markets, currently enjoying 100% tax exemption - after a 12 month period. If indeed this exemption is withdrawn, it will deal a blow to the charm of equities, which has been a bright spot off late and the gains from such a move may not be commensurate. 

On the contrary, to encourage investments in debt funds and to standardise the holding period across various asset classes, the minimum holding period for long-term capital gains should be reduced from 36 months to 12 months. 

• Keeping the Inheritance tax dragon at bay:

Estate duty (popularly known as 'Inheritance tax') was done away in 1985. The reason it was scrapped was because the yield from this duty was much lesser vis-à-vis its administration cost.

Speculations are rife that this Budget may have provisions for reinstatement of estate duty - particularly impacting the high net worth individuals and the same being in sync with the Government's stance of targeting the affluent class for uplifting the country's economy. Year 2017 therefore expectedly witnessed a lot of hustle and bustle amongst this section of the society, with lot of them aggressively opting for family trust structures. 

While bringing this 'dead tax to life' may help the Government collect some taxes, the same could prove to be detrimental for a lot of families. The FM needs to keep in mind the Indian context of lot of businesses being family run, and the impact that a break-up of such businesses, necessitated by imposition of estate duty, may have on the growth of the economy. 

In this background, the following quote of the great statesman Kautilya comes to mind - “A tax collecter should collect taxes from a taxpayer just like a bee which collects honey from a flower without disturbing its petals”. Deriving an analogy, just as the unscathed way in which a bee collects honey, the Hon'ble FM needs to juggle around and strike a pragmatic balance between fiscal prudence, political diplomacy and common man's appeasement. Will he be able to pull off this Herculean task on the Budget day? Let's see what unfolds on 01 February.

The article has been Written by Pramod Achuthan (Tax Partner, Ernst & Young LLP) with support from Aabhishek Khurana (Manager).

Budget 2018 - Will it Bring Concrete or Façade?

Real Estate sector, the second largest contributor to the economy, in the recent past, has witnessed a flurry of policy, regulatory and GST reforms being implemented to promote the growth and increase transparency to improve the overall economic growth of the country.  The sector applauded granting of infrastructure status to affordable housing, increased focus on infrastructure development and reduction in GST rate for affordable housing segment under Pradhan Mantri Awas Yojana in the recent past.  

During the year, the Government ensured successful roll-out of a Real Estate (Regulation and Development) Act (RERA), Goods and Services Tax (GST), relaxations in the annual budget for affordable housing projects, incentives under the Pradhan Mantri Awas Yojana (PMAY) Scheme have provided a much-needed boost to the sector.  The results of these various reforms will help the reeling sector and will lift the sector. 

The upcoming Budget, being the last full Budget of the Modi Government, is looked upon by the industry for reforms in the tax arena in the form of tax incentives and rationalization of certain provisions of the Income-tax Act, which could give the much needed impetus to the sector and help in reducing the demand-supply gap and will help propel the sector towards a sustained growth path for the long-term.

Some of the much needed challenges need to be addressed by the Budget 2018 to provide the much needed impetus to the sector.-

A. Challenges of Real Estate Developers

• While RERA will transform the sector and bring much needed transparency in place, multiple layers of approvals results in delay in project delivery, which has far reaching fiscal ramifications. The Government should introduce self-clearance or single-window clearance mechanism to fast track the growth of the sector and overall economic growth as well. 

• The shift of benefits from incentive based under section 80-IA to expenditure based under section 35AD has not helped the infrastructure sector and more particularly real estate sector (affordable housing or housing sector as part of the highway projects) as the incentives are not available in respect of land cost and given the business model, real developers do not invest significantly in the capital assets, which is eligible for incentives u/s. 35AD. Further, the levy of MAT of 21% effectively takes away the benefits, if any for companies engaged in these businesses and appears to be an “Eyewash”. Therefore in order to provide real benefits of this section, exclusions should be provided from the levy of MAT. Further, the benefits should also be extended to developers developing, operating or maintaining Integrated Township Projects by including the same within the definition of “Infrastructure Facility” as almost 40 to 60 percent of the project cost comprises of various social infrastructure facilities like roads, sanitation facilities, educational and medical facilities, etc. as part of Integrated Townships. 

• The relaxations provided by Finance Act, 2017 in relation to tax incentives for affordable housing projects was a welcome move, but it provides that the benefit is available projects approved before June 1, 2016. This is one of the bottleneck given the municipal regulations and the interpretation of the term” building plan of such housing project was first approved by the competent authorities”. Many of the existing projects have been approved by the regulatory authorities, but no work has been started and the developer wants to switch over framework, develop affordable housing project and they would not be eligible for the benefits. Considering this impediment, the Government should provide necessary clarifications that those projects will also be eligible if the revised building plans of affordable housing project is approved by the authorities post 1 June 2016. Further, profits from the business of affordable housing should also not be subjected to MAT to provide real impetus to this segment.

• Joint Development Agreement (JDA) has evolved as an effective model for the Real Estate sector.  However, there exists an uncertainty with respect to the point of levy of capital gains tax in case of tax payers other than individual and HUF. The divergent judicial precedents have created more uncertainty and more particularly, when the land is held as “stock in trade” by the land owner. The Finance Act 2017 provided some relief to individuals and HUF in relation to capital gains and the levy has been postponed till the Certificate of Completion (CC) is issued by the competent authority in respect of the project developed under JDA.  This relief is granted only in respect of area share and revenue share arrangements. It is recommended that this relief should also be extended to tax payers other than individual and HUF and both revenue share and area share arrangement should also be eligible for such benefits. These amendments will help in avoiding enormous amount of litigation. In fact, Central Council has recently postponed the levy of GST in respect of development rights till the construction is completed and hence, similar relief should be provided in respect of point of levy of taxation. 

• The Finance Minister has been committed to the revival of SEZs and the Infrastructure of the Country.  Towards this commitment, extension of the sunset clause on SEZ's is crucial for developers, especially in the midst of the anticipated impact of automation, technology and US Tax Reforms on the IT sector. Revival of tax incentives in respect of SEZs will impact the exports and job creation. At the most, MAT exemption should be reinstated for the SEZ developers and SEZ units.  This will boost the industrial development, exports and more importantly generate significant employment thereby creating positive impact on the overall economic growth. Further, 

• Finance Act, 2017 amended Sections 22 and 23 of the Income Tax Act, wherein annual value of unsold stock-in-trade in the hands of real estate developers held for a period beyond one year from the end of the financial year in which the certificate of completion of construction is obtained would be notionally taxed as deemed let out property. This amendment was brought about as a means to promote the real estate sector, however it created a negative sentiments and impact on the bleeding sector as developers are unable to sell their existing stock in the sluggish market. In view of the genuine hardship faced by real estate developers, the Government should consider withdrawing this levy or at the most increasing the exempt period to at least three years.

• The provisions of section 43CA and section 50C providing for deemed taxation based on stamp duty valuation should be removed and any suspected understatement of consideration should be tackled through other mechanisms such as investigation mechanism.  Alternatively, specific exclusions should be provided from the applicability of section 43CA and section 50C such as transfer under gift, distressed sales, slump sale, reorganizations, etc.

• The reduction of GST rate to 8 percent for affordable housing projects under CLSS Scheme of the Housing for All (Urban) Mission and Pradhan Mantri Awas Yojana (PMAY Urban) is a welcome and a step in the right direction. The Government should consider, extending this lower rate of 8 percent to all the real estate projects as it will not only foster the growth of housing development sector but will also make the housing affordable for the home buyers. 

B. Benefits to the Home Buyers

• The present threshold of deduction in respect of interest on housing loan should be enhanced to at least INR 500,000 to encourage home-buyers to invest in real estate and help improve the demand in the market. Further, the deduction under section 80C for principal repayment of housing loan should also be increased from the existing limit of INR 150,000 to INR 500,000.  Alternatively, one time deduction be introduced for the first time home buyers in respect of purchase price of a house (upto certain limit say Rs. 50 lacs) and such deduction be spread over a period of 5 years.

• The Finance Act, 2014 amended the section 54F to restrict the exemption in case the person holds more than one residential house (other than the house in which investment is made). This has impacted the investment in the residential segment and diverted the funds from the sector which is facing liquidity challenges. In order to boost the sector as well as will encourage the home-buyers to invest and lead to improved affordability on account of both rental housing and improved supplies of housing stock. 

C. Facilitating roll out of REIT and InvIT

• In order to make REIT and InvIT more attractive and to create liquidity to encourage small savings in the sector, suitable modification should be made to the provisions of the Act provide for a lower holding period of 12 months (instead of present 36 months) in respect of units of REIT and InvIT so as to qualify as long term capital asset.

• Transfer of shares of the Special Purpose Vehicle (SPV) in exchange of units of REIT / InvIT is not taxable at the time of such exchange under the normal provisions as well as under MAT.  It is recommended that similar relaxations be provided for transfer of asset being immovable property to REIT / InvIT.

• Suitable amendments should be made so as to allow carry forward and set off of losses to the SPVs in case of transfer of more than 51% shares of a closely held company to REIT / InvIT, considering the fact that lapse of losses can hamper the viability of REIT and InvIT.

• SEBI has amended REIT and InvIT regime to provide for two layer holding structure given the industry practice and hence, the Government should amend the taxation regime to provide pass through tax treatment in respect of such two layer holding structure. 

Summing Up:

India's strong economic fundamentals, coupled with the pro-reforms stance of the Government have been pivotal in creating an investor-friendly environment in the recent years.  Global investors have been showing positive interests in the Indian market.  With growing transparency and improving policies, the country's real estate sector is expected to become more organized while also witnessing an increased capital flows and reduced demand-supply gap. The above stated relaxations along with other favorable policy changes will help the currently ailing industry to perform better and continue to contribute to the Indian economy.

The article has been co-authored by Vyomesh Pathak (Chartered Accountant). Jigar Vora (Chartered Accountant) has provided valuable contribution in preparation of this article. 

Pre- Budget expectations : Transfer Pricing

The Union Budget 2018-19 is round the corner and expectations from the Government are high as this would be the last comprehensive budget before the elections in 2019.  Over the past, Indian government's policies and initiatives have been focused on digitization, technology, entrepreneurship, education, skills development, sanitation and so on.  It is palpable that the government has been riding high on drivers that are imperative to the economic and social growth of the country. 

In the light of above, growth, infrastructure development and employment are expected to be the central pillars of the upcoming budget. It is well conceived that PM Modi's 'Make in India' and 'Digital India' initiatives can fuel the slackened growth and help India achieve the projected GDP growth rate at 7.5% to 8%. Now to make these initiatives a successful reality, progressive reforms are expected to be under the spotlight in the upcoming budget.  In this backdrop, 'ease to do business in India' will be the central theme. Therefore, it is hoped that the Budget would rationalize tax provisions and provide more clarity on their application to address the objective of ease of doing business in India. 

Apart from above, this article seeks to highlight certain areas where changes and clarifications are expected in this budget with regard to Transfer Pricing provisions. Some of our key expectations from Transfer Pricing perspective are discussed below: -

1. Safe Harbor Rules (“SHR”)

The recently amended SHR have provided for lower rates of operating margins.  However, it is suggested that in order to widen the scope of SHR, there should be inclusion of sectors / transactions like development of patents by pharmaceutical sectors, manufacturing and exporting the product as contract manufacturer/ loan licensee.  It is also suggested that the upper limit of value of transactions should be enhanced from INR 200 Cr to extend the benefit of SHR and reduce the compliance burden of taxpayers. This step shall assist in reducing the perpetual litigation process.

2. Range to be broadened to 25 percentile to 75 percentile

Central Board of Direct Taxes (“CBDT”) has notified rules for using the range concept and multiple year data in determination of Arm's Length Price (“ALP”).  Accordingly, 35th to 65th inter quartile range was defined.  However, it is reasonable to argue that the defined range is narrow and does not adhere to the global standards.  Thus, it is recommended that an inter quartile range of 25th to 75th percentile should be prescribed since it is an internationally accepted standard. 

3. Secondary Adjustment

Finance Act, 2017 inserted Section 92CE under the Act i.e. secondary adjustment which implies adjustment in the books of account of the taxpayer and its Associated Enterprise (“AE”) to reflect actual allocation of profits between the taxpayer and its AE in line with the ALP principle as embodied under Chapter X of the Act read with Rule 10 to 10E of the Income Tax Rules, 1962 (“the Rules”). 

In this respect, clarity would be required with respect to allocation of secondary adjustment wherein international transactions with Multiple AEs are benchmarked using entity wide Transactional Net Margin Method (“TNMM”) on an aggregated basis.  Clarification is sought on the basis of allocation of quantum of secondary adjustment to different AEs for adjustment to be made to the overall net margin of the taxpayer w.r.t. multiple AEs/ transactions.

Further, repatriation of funds from overseas entities/ AEs might pose a problem since such repatriation might not be permitted according to the tax laws of the country in which the AE operates.  Additionally, it may lead to double taxation on the same income as the AE may have already paid taxes on such income in its resident country.

4. Relaxation in compliance of CbCR and Master File compliance 

As FY 2017-18 is the first year of compliance of country-by-country reporting and master file. Relief should be provided to taxpayer by extending the prescribed timeline and relaxation of stringent penalties for the said compliance.Relaxation in timelines and stringent penalties of CbCR and Master File compliance, as FY 2017-18 is the first year of compliance.. The current limits for preparation of detailed Master File is quite low and casts significant compliance burden for MNC's having group turnover of only 80 MUSD. It is recommended that the monetary limits for preparation of Master File should be revised upward, in line with global benchmarks

5. Specific Guidelines on complex Transfer Pricing Issues

Absence of guidelines in the present law pertaining to issues like location Savings, Marketing Intangibles, Intra-group services etc. along with contradicting judgments on some of these matters and no clear guidance on what methodologies can be adopted by the taxpayers for determining arm's length price has lead to uncertainty among taxpayers and revenue authorities, resulting in prolonged litigation. It is therefore important to address this issue to end the ambiguity.

6. Limitation of Interest Benefit under Section 94B of the Act

The Finance Act, 2017 also introduced Section 94B under the Act limiting the payment of interest to the AE.  However, considering that India is a developing nation, companies need debt for restructuring purposes and therefore, capping the interest to 30 percent of the EBITA shall restrict the Foreign Direct Investment (“FDI”) for the nation.

Therefore, it is recommended to rationalize the threshold limit for interest disallowance from the current 30% to 50%, as also to provide exemptions for Start Up companies and loss making companies. 

7. Valuation under Custom and Transfer Pricing

Currently, both Custom law and provisions of Chapter X of the Act read with Rules require the taxpayers to establish the ALP with respect to transactions between related parties.  Given the different objectives under the respective laws, the taxpayers find it difficult to align the value of related party imports  from a transfer pricing and customs perspective causing unnecessary hardship to taxpayers. 

In this Budget, we expect that CBDT lays down guidelines for establishing a common platform that would provide a 'middle-path' for determining ALP that is acceptable under both Customs Law and under the Transfer Pricing regulations.

Filing of Form 3CEB by Foreign Companies

Currently the Indian transfer pricing regulations provide that every person who has entered into an international transaction is required to prepare and file form 3CEB and also maintain transfer pricing documentation, if its value of international transaction exceeds INR 1 Crore. In this connection, their are diverse views whether foreign companies are required to file Transfer Pricing report in Form 3CEB in India, even if income subject to an international transaction is not chargeable to tax in India or where the transaction entered with the foreign entity is already reported by the Indian entity in its Form 3CEB as per the provisions of the existing Indian transfer pricing law.  It is suggested that the Government of India should clear the ambiguity surrounding this issue by clarifying that the provisions of Indian transfer pricing would or would not apply to foreign companies/ foreign residents unless they have a permanent establishment in India. Bearing in mind the intent of the TP provisions it is suggested that the base erosion concept should be recognized qua the transaction and not the taxpayer.

8. Block assessment to be considered

The transfer pricing assessment is a gruel-some process for MNC corporations operating in India, with the calling of significant details on the transactions and the manner of benchmarking the same. Under the current transfer pricing regime, assessment is carried out separately for each assessment year irrespective of the nature of the issue.  It is suggested that block assessment of 3-5 years should be considered for issues like royalties and other principle issues, as issue involved is/ are cyclical in nature and carrying out a separate assessment for every year results in wastage of time, money and efforts of the taxpayer as well as of the Tax Department.  This shall facilitate in aligning our practices with global best practices.  Such block assessment will free up administrative resources and will also reduce the litigation burden of the taxpayer.

9. Clarify Transfer Pricing Rules

Presently a significant number of transfer pricing cases litigated in tax tribunals are on conceptually on trivial grounds such as consideration of a particular item of income/expense as operating/non-operating in nature, threshold for application of related party filter, turnover filter, persistent loss making comparable, etc.  To reduce unnecessary litigation, these issues can be suitably clarified by the government in the current budget.

Conclusion

All said and done, as the current government will present its last full-year budget before the 2019 general elections, many in the industry expect a heavier dose of populism. On one hand, the Government is striving hard to rein in fiscal deficit and inflation while at the same time aspiring to garner adequate resources through taxes to fund its various projects and schemes. Lastly, we believe that addressing the aforesaid will resolve the practical difficulties faced by taxpayers while conducting the TP analysis or TP audit defense. It will also bring in a level of certainty to the TP issues and attest the Governments motto statement of a non-adversarial tax regime.

The article has been co-authored by Amit Agarwal (Partner, Nangia & Co LLP). Anchal Kapoor (Associate Director of Nangia & Co LLP) and Aakansha Gupta provided valuable inputs in preparation of this article. 

Income Computation and Disclosure Standards - Are these standards here to stay for long?

It has been a matter of significant debate as to whether there is a necessity for separate accounting standards for computing taxable income and for regulating disclosure of accounting policies for computing taxable income.

For several years now, taxpayers have followed accounting standards which were adopted for preparation and presentation of statutory accounts, with necessary adjustments to reflect the deviation between the Income-tax Act (the Act) and accounting standards. It was settled law that where the Act is silent, it would be appropriate to provide the same treatment for income-tax purposes as is in accordance with the accounting standards followed for preparation of statutory accounts.

However, the government thought it wise to enact a separate set of accounting standards vide an amendment to Section 145 of the Act. The purpose for the said amendment was to reduce disputes and standardize the accounting treatment to be provided while computing taxable income. The government being empowered to notify Income Computation Disclosures Standards (ICDS) vide the said amendment, notified 10 ICDS, applicable from assessment year 2017-18. The implementation of ICDS has seen its own set of challenges. The implementation had to be postponed for one year from its original applicability, and in the interim, the notified ICDS had to be revamped comprehensively to reduce significant ambiguities in the original ICDS. The revamp was followed by frequently asked questions to provide further clarifications.

However, despite government's best efforts to provide necessary clarifications, the dust was far from getting settled on the ICDS. In Chamber of Tax Consultants v. Union of India [2017] 87 taxmann.com 92, the Chamber of Tax Consultants challenged the legal validity of ICDS, arguing that the provisions of ICDS were beyond what delegated legislation can legally provide for. The Delhi High Court considering the powers of the Central Board of Direct Taxes under Section 119 of the Act, held that such powers are conferred to simplify or clarify the law and not to amend the law, a power which is vested solely with the Parliament. In conclusion, the High Court struck down certain ICDS in whole or in part.

The decision of Delhi High Court has added to the complexity since it has been selective in striking down the provisions of ICDS. A partial strike down does not relieve taxpayers of the administrative burden of maintaining separate set of memoranda accounts for tax purposes. Further, the applicability of the said decision on taxpayers in states under jurisdiction of other High Courts is also a matter of debate.

With the amount of complexity surrounding its implementation, taxpayers have certainly not benefited from the implementation of ICDS. Further, the process of computing income based on ICDS and keeping an ongoing record of various deviations and adjustments is extremely cumbersome and burdensome for taxpayers. Instead of simplifying the law and reducing controversies, ICDS has seen several controversies in the first year of its implementation, which is likely to continue.

It would also be important for the government to examine whether ICDS has benefited the Revenue in any manner. Post implementation of ICDS there is a likelihood for tax payments to marginally go up since ICDS advances recognition of income and postpones deduction of expenses. However, as most of these adjustments are timing differences, there would not be any significant increase in taxes collected by government.

It is key expectation from the present government to improve the ease of doing business in the country. Even in respect of direct taxes, there has been a significant emphasis on ensuring a stable and predictable tax regime, with minimal litigation. On the other hand, ICDS has been perceived by the business community to impose an avoidable compliance burden as well as a fresh ground for tax authorities to litigate on several settled issues which have been unsettled by implementation of ICDS.

It would be revealed on the presentation of Budget 2018 whether the government repeals ICDS or strengthens it by incorporating material provisions of ICDS in the Act itself or even adding new ICDS to provide for accounting treatment on transactions not yet covered by present ICDS. It would be quite interesting to look at Budget 2018 to ascertain the future of ICDS in India.

The article has been co-authored by Chintan Shah (Manager, Deloitte Haskins and Sells LLP) and Darshin Haji (Deputy Manager, Deloitte Haskins and Sells LLP). 

Budget 2018 expectation: Introduction of Tax Consolidation Scheme in India

In the era of specialization, companies are set up with a specific objective and work in a specialized line of business. In India, it is quite common to create subsidiaries to carry out various businesses in separate lines such as oil and gas, telecom, FMCG etc. Thus, a particular business group as whole, may through different corporates do business in India in separate lines of businesses, each dedicated to a specific area. The intention here is to have operational, managerial or financial convenience. However, under Income Tax Act, 1961, every company is considered as a separate entity for tax purpose, resulting in multiple compliances of same nature for each of the company in the group, for filing of return of income.

However, to avoid such multifold compliances of similar nature and ease administrative work, some developed countries such as United States, France, Australia  have adopted tax consolidation regime which treats a group of wholly-owned or majority-owned companies as a single taxable entity for the purpose of tax. Normally, head entity of the group is responsible for most of the compliances of the group as a whole. This means one return of income for the group as a whole doing business in India.

Considering the efforts of the government to provide ease of doing business in India, it is much expected to introduce such tax consolidation regime in Budget 2018 providing a voluntary option to the head entity to opt for the same. Also, it shall help provide fiscal unity reducing compliance burden and avoiding multiple litigations at various levels for separate companies in a group.

From the perspective of the tax department, the same shall provide administrative convenience; for example, a single assessee group as a whole for scrutiny as against individual companies. Moreover, the tax payer and the tax department shall be benefited in terms of cost and time, apart from reduction in maintaining multiple records. Further, it would end the tax litigation and uncertainties attached in respect of intra group transactions.

Also, litigation shall reduce significantly with consolidation of taxpayer in one group assessee. Therefore, tax consolidation scheme in India shall not only help taxpayers through lesser compliances, but shall also benefit the tax department in reduced administrative burden, creating a win-win situation for both sides.

It would also be possible to provide group relief in tax consolidation scheme which allows losses or unabsorbed depreciation of a group company to be set-off against the profit of other group entities. Also, MAT credit of one entity can be utilized by group in reducing taxes. Such group relief structure shall not only attract investors but also provide incentives for start-up in different lines of business by established business houses. 

With the government planning to improve ease of doing business index for India and with concepts such as 'start-up India' and 'Make in India', it is expected that Budget 2018 could likely introduce the tax consolidation scheme reducing time, cost and compliances for business houses from the direct tax perspective. Just as GST was termed as “Good and Simple Tax”, it is expected that the government would take similar measures to align direct tax with international best practices and incentivize investment in India.

The article has been co-authored by Kinjesh Thakkar(Deputy Manager, Deloitte Haskins and Sells LLP).

US Tax Reforms - India Impact & Response

The US economy is the largest economy in the world. According to the latest World Bank figures, its GDP of ~$18.5 trillion represents almost a quarter share of the global economy. Therefore, the recently enacted tax reforms in the US via the US Tax Cuts and Jobs Act (the Act)  will have implications not only in the US but globally as well. These reforms will impact Indian businesses also as the US is India's largest trading partner. 

The objective of the reforms is to boost the US economy, spur investment and create jobs in the US and make US corporations globally competitive. The underlying theme is also to discourage US corporations from shifting production and intangibles abroad or to low tax jurisdictions. 

While the Act has introduced many changes, the focus of this article is on the changes which are important for both Indian outbound and inbound businesses. The article also briefly highlights measures to make India's tax system competitive in light of the US tax reforms. 

Alignment with territorial tax system

The Act moves the US tax system from a worldwide system of taxation (where US corporations are taxed on their global income) closer to a territorial system of taxation. This has been accomplished by providing for a 100 percent deduction from dividend received from foreign subsidiaries by US parent that owns at least 10 percent in the subsidiary. The worldwide tax system coupled with the high tax rate had put US businesses at a disadvantage to their foreign competitors and was cited as one of the reasons for US businesses shifting business activities to other countries. The US was one of the few countries to follow the worldwide system of taxation. The current move aligns its taxation system closer to most other developed countries in the world that follows territorial taxation system. One can argue that even now the US system is not fully akin to territorial system as the Act levies tax on non-routine income of controlled foreign corporations (CFCs), albeit at a lower rate.

Corporate tax rate reduction

The US federal corporate income tax rate has been reduced from 35 percent to 21 percent for tax years beginning after December 31, 2017. Before the tax rate change, the US had the highest corporate income tax rate among the OECD countries. The US corporate tax rate, combined with average state and local corporate rates was ~38.9 percent. The combined US corporate tax rate will reduce to ~25.75 percent as a result of the tax reforms. While this rate still will be two percentage points higher than the ~23.75 percent average rate for all OECD nations, it is still significantly lower than India's headline corporate tax rate of 30 percent (without considering surcharge and cess). Coupled with the dividend distribution tax of 20 percent, the effective tax cost of doing business in India is significantly higher currently.

The reduction in the federal corporate tax rate will lead to a reduced tax outgo of the Indian companies with US operations. It might incentivize the Indian businesses to restructure their operations and move more profits in the US. For example, the businesses could explore conversion of a marketing service entity in the US into a distributor. However, any change in the business structure or transfer pricing policy now will be subject to more scrutiny by the Indian revenue from transfer pricing, general anti avoidance rules and place of effective management perspective given the low tax rate in the US.

Base erosion anti-abuse tax (BEAT) 

The purpose of BEAT is to target erosion of the US tax base by imposing an additional tax liability on certain corporations that make base-eroding payments (e.g., interest, royalty, etc.) to foreign related parties. Cost of goods sold is not subject to BEAT. 

Simply put, BEAT is an alternate minimum tax that would be imposed if 10 percent (lower at five percent for 2018 but enhanced to 12.5 percent for tax years beginning 2026) of the modified taxable income exceeds the taxpayer's regular tax liability. The modified taxable income is the taxable income adding back any base-eroding payments. BEAT is applicable to corporations with average annual gross receipts of at least $500 million. Thus, the impact of BEAT will vary depending on the exact facts of the case, quantum of taxable income and base-eroding payments. 

While BEAT is applicable to payments made to related parties for services, it is not applicable to certain low value adding services (e.g., payroll processing, accounts payable and receivables, recruiting, etc.) specified in the US transfer pricing regulations for charge out at cost. 

Services remain a key component of India's export to the US. Currently, to comply with the transfer pricing regulations, these services are charged with a markup on cost. Let's say the total invoice value of services is INR 115 which includes cost of 100 and profit of 15. What is not clear is whether only the profit element of 15 will be subject to BEAT or the total value of 115. It remains to be seen how the exception for services charged out at cost will be applied in practice to Indian companies providing back-office services to US based companies. Nonetheless, BEAT could partially offset the cost arbitrage of outsourcing work to India.

Since BEAT will be an additional tax cost for the US subsidiary of Indian businesses, the businesses will explore restructuring their operations to minimize the impact of BEAT. This could, for example, involve conversion of a sourcing service entity in India into a direct selling entity as cost of goods sold are not subject to BEAT. Also, BEAT could see certain toll manufacturing arrangements being converted into contract manufacturing arrangements as toll manufacturing fee could be subject to BEAT, while cost of goods sold under contract manufacturing may not be. 

However, any such restructures have to be obviously carefully planned after due consideration of relevant anti avoidance rules / business purpose doctrines prevalent in both jurisdictions. 

Interest limitations

The Act limits the interest deduction to 30 percent of EBIDTA for taxable years beginning after December 31, 2017 (30 percent of EBIT for taxable years beginning after December 31, 2021). The disallowed portion will be allowed to be carried forward indefinitely.

These provisions could impact Indian businesses that have financed their US operations with significant level of debts. There is no grandfathering for existing debt. Therefore, Indian businesses with US operations will need to conduct an impact analysis right away and should devise an optimal capital structure keeping the interest limitation rules in mind.

Global intangible low-taxed income (GILTI) and Foreign derived intangible income (FDII) 

The Act has enacted two provisions to discourage US corporations from shifting intangibles overseas (GILTI) and to encourage them to retain or shift back intangibles to the US (FDII).

Simply put, GILTI requires a US corporation to include in its income the non-routine income of its CFCs. Any income of the CFCs over and above a routine return of 10 percent of tangible assets will be taxed in the US at an effective tax rate of 10.5 percent. Credit will be allowed against such tax for 80 percent of the foreign taxes paid on such income. Therefore, this provision will not lead to increase in the overall tax cost for the businesses as long as such income has been subject to tax in the source country at 13.125 percent or more. Considering that India's headline corporate tax rate is 30 percent (without surcharge and cess), this provision may not give rise to additional tax liability in the US.

Further, to incentivise US corporations from commercially exploiting US based intangible assets internationally outside the US, the Act allows such corporations a deduction on their income from such commercial exploitation (e.g., sale of property, provision of services, royalty) such that the effective tax rate on such income stands reduced to 13.125 percent. These provisions are akin to patent-box regime that provides for lower taxation on income from US intangibles from outside the US. 

In the last few years various countries have either enacted or enhanced their patent box regimes (e.g., the UK, Italy, Spain, etc.). Therefore it will be interesting to see if the FDII provisions lead to migration of IPs to the US. However, businesses should consider the impact of potential exit charge and also ensure that any IP transfer meets the arm's length test.

Deemed repatriation

Before the enactment of the Act, US corporations holdings shares / equity in overseas companies were taxed on their share of earnings of such companies at 35 percent when they were repatriated back to their US parent. The high tax rate of 35 percent discouraged many US Corporations from having the earnings repatriated to the US by way of dividend. As part of a move to a territorial system and as a one-time incentive to encourage US corporations from bringing the cash back to the US, the Act provides a lower deemed repatriation tax of 15.5 percent on earnings held in liquid form and 8 percent on earnings held in non-liquid form. This is regardless of whether such profits are now repatriated or not.

The tax will be payable on amounts determined as of November 2, 2017 or December 31, 2017, whichever is higher. The tax can be paid in 8 instalments.

This provision will impact the Indian subsidiaries of US multinational with non-repatriated earnings. One also needs to bear in mind that dividend distribution is subject to tax at 20 percent in India. Therefore, Indian subsidiaries will need to work out tax optimal repatriation strategies within the ambit of law to mitigate the additional tax cost of repatriation.

The purpose of the above provision is to encourage US corporations to bring cash back to the US to spur investments and growth. One can argue that the measure has already started to bear fruit. As per recent media reports, few corporation (Apple, Honeywell, Fedex, etc.) have already announced bringing cash back for investment into the US.

Accelerated depreciation

The Act provides for full deduction on investment in qualified capital assets. This provision coupled with the low tax rate in the US will make new investments and expansion of manufacturing capacity in the US more attractive for Indian businesses. Indian businesses with large share of US exports might find it attractive to set up manufacturing base in the US or acquire existing US businesses. A recent media report suggests that some of the Indian pharma companies are exploring setting up of Greenfield manufacturing plant in the US.  

Response from the Indian policy makers

The US tax reforms have led to the most significant overhaul of the US international tax system. These reforms will have significant global implications due to the size of the US economy. 

While the European Union has criticized certain provisions of the US tax reforms, certain countries have already started to introduce measures in response to the US tax reforms. For example, China has decided not to impose withholding tax on dividend distributed by Chinese enterprises to their foreign investors if the divided is reinvested into specified industries in China.

We are just a day away from the Indian union budget. With the reduction in the corporate tax rate by the US, other countries might follow suit as well to keep their tax rate competitive. The Indian policy makers would have considered the impact of the US tax reforms while drafting the budget and would have incorporated appropriate measures to make India's tax system competitive. The measures among others could include the following:

• Reduction in the corporate tax rate: While presenting the budget for 2015-16, the finance minister announced a roadmap for phased reduction of headline corporate tax rate from 30 percent to 25 percent while simultaneously eliminating exemptions in a phased manner. The process of reducing the corporate tax rate has not been kicked off yet, except for the fact that the corporate tax rate for small companies with annual turnover of INR 50 crores have been reduced to 25 percent. The US has reduced the tax rate significantly. Japan's ruling bloc has announced plans to reduce the corporate tax rate from 30 percent to ~20 percent. The UK has announced a reduction in the corporate tax rate to 17 percent from April 2020. Considering the reduction in tax rate by the US and also other countries in the recent years, the corporate tax rate in India should be reduced to 15-20 percent for India to remain competitive from tax perspective. This coupled with the dividend distribution tax will still lead to a high effective tax rate of 30-33 percent.

• Abolition of dividend distribution tax: Currently, dividend distributed by Indian companies are subject to tax of ~20 percent in the hands of the distributing company. This leads to an increase in the effective tax cost for companies. This budget is an opportunity for the government to reduce the effective tax cost by abolishing the dividend distribution tax. Overall, the government should set the effective tax rate at a competitive level by reducing corporate tax rate and/or abolishing dividend distribution tax.

• Enlarging the scope of safe harbour for R&D activities: India has around 1200 MNC R&D centers. India introduced transfer pricing safe harbour rules to provide certainty to taxpayers providing various services (e.g., software development, contract R&D, IT enabled services, etc.) as long as the margin earned by taxpayers is equal to the safe harbour rate. However, the safe harbour rules cover contract R&D in pharma and software development only. Further, the margin prescribed for contract R&D is on the higher side (24 percent). Also, the safe harbour is not applicable for companies where the value of R&D services is more than INR 200 crores. The scope of the R&D activities eligible for safe harbour should be enhanced. Further, the safe harbour margin should be reduced so that there are more takers for the safe harbours. This will go a long way in transfer pricing dispute prevention and make India a more attractive destination for setting up and ramping up R&D centers.

Conclusion

Indian taxpayers (both inbound and outbound) should keep a close watch on the US tax developments and review their supply chain, IP ownership and financing structures in light of these changes and also considering that some of the significant changes are applicable from January 1, 2018. Taxpayers will be keeping an eye on the budget as well for India's response to the US tax reforms.

While the US tax rate is competitive now, India still offers various non-tax benefits such as lower cost, talent pool, emerging middle class and market size. All these factors together with tax competitiveness will be critical while considering capital allocation / budgets and new investments in the context of India vs. the US.