The much-awaited Union Budget 2019-20 is to be presented by Hon'able Finance Minister Ms Nirmala Sitharaman on July 5, 2019. This will be the first full Budget of the Modi Government 2.0 and all eyes are on reforms and new initiatives to be announced by the Government.

The important aspects that the Budget may focus will include philip to infrastructure and manufacturing sectors, providing impetus to the initiatives such as Make in India, Digital India, Skill India, etc., generate employment, rural development, benefits to small and medium enterprises (SMEs) and common man, promoting digital means, etc. The Government will also need to give due consideration to fiscal aspects.

This article focuses on some key expectations and recommendations from upcoming Union Budget from direct tax perspective as below. 

DIRECT TAX:

1. Corporate tax rate:

· The Hon'ble ex-finance minister Shri Arun Jaitley had announced a road map to reduce corporate tax rate from 30% to 25%. Currently, the corporate tax rate applicable is 30%. In Finance Act, 2018 the corporate tax rate was reduced to 25% in case of specified companies. The corporate tax rate is further increased by surcharge and cess as applicable.

Further, the Firms and the Limited Liability Partnerships ('LLPs') continue to be taxed at 30%.

· Although, the Indian tax rates have been on decline in the last decade, compared to developed countries across the globe, the Indian tax rates are still high. In order to make Indian corporates competitive in the global market and also enable them to attract foreign investments, the tax rate needs to be rationalised. The list of key select countries and their prevailing tax rates are as under:

Key recommendations:

· Base corporate tax rate may be reduced from 30% to 25% for all the corporates.

· Surcharge and cess may be removed. It is worth noting that surcharge should be levied in case of emergency situations but it has become a means of tax collections over years. As a matter of policy, base rate should be made the effective tax rate going forward.

· The concept of levying minimum tax on book profits of corporates was introduced to bring in the tax bracket corporates making huge profits but not paying / nominal taxes (which is most likely in case of corporates claiming incentives / exemptions). Since most of the incentives / exemptions available to select sectors and industries are being phased out, Minimum Alternate Tax ('MAT') applicable in case of companies and Alternate Minimum Tax ('AMT') in case of non-companies may also be phased out. In any case, the rate on MAT should be 10% or less. This would be in line with the 'ease of doing business' initiative and would help mitigate liquidity or cash crunch for businesses.

2. Boost to economy:

In order to boost the Indian economy, various initiatives have been undertaken by the Government of India - such as 'Make in India' initiative, start-up schemes, relief from angel tax to start-ups etc.

Key recommendations:

In line with the objectives of the Government and its constant effort to attract foreign investments, create employment opportunities, increase the per capita income, etc., key recommendations are:

· Profit linked incentives in form of deductions / exemptions to select sectors and industries have expired / will expire by April 2020. Government may consider extending the period for such profit linked incentives for projects commenced over next 3 years eg for new industrial undertakings, infrastructure projects, waste management, etc.

· Alternatively, the Government may consider providing additional depreciation, investment allowances (on the lines of erstwhile provisions of section 32AC), weighted deduction (something similar to provisions of section 35AD of the Act) to key sectors / industries - such as infrastructure, manufacturing, pharma, etc. with a rationalised approach.

Boost to the economy would essentially result into creation of new job opportunities. Further points listed as under may also be considered in order to create employment opportunities:

· In order to boost employment provisions of section 80JJAA were introduced in the past. However, such deduction benefits are available in case the total emoluments payable to the employees does not exceed INR 25,000 (subject to other conditions). It is recommended that such threshold may be increased to INR 50,000. Also, the stringent conditions for the applicability of provisions section 80JJAA may be rationalised.

Further, as per the public data available, there has been a fall in women's participation in Indian labour force from 36.7% (2005) to 26% (2018). In order to bring parity and encourage women empowerment, the Government may consider providing additional benefits to industries where the ratio of women to man employees meets the specified threshold. This will also address gender diversity. 

· One of the objectives of Make in India initiative as well Start-up India was to generate employment / self-employment opportunities. In line with the same many incentives / exemptions have been provided to start-ups in India. Recently, an exemption was provided to start-ups having a turnover of less than INR 100 crores from the applicability of angel tax provisions. However, the threshold of turnover for claiming the benefits under the provisions of section 80-IAC of the Act still continues to be INR 25 crores. The Government may consider extending the benefit of increased turnover threshold in case of applicability of provisions of section 80-IAC of the Act.

3. Widening of tax net:

Although India is a highly populated country, the number of taxpayers is insignificant. One of the important objectives of this Government is to widen the tax base. Across the globe successful tax administrations are efficient, transparent and taxpayer friendly. These administrations rely on third party information reporting mechanism, data compilation / data analytics, etc. to capture the tax base.

Key recommendations:

The Indian Government may adopt, similarly, the following practices:

· The Government should focus on data matching - i.e. matching of data (say for instance, revenue declared with the GST authorities, registrars, etc.) with the income tax return filed. Data matching areas of focus may include - interest income, capital gains on account of transfer of property, distributions from partnership firms, trusts, etc. Data analytics systems adopted across the globe of select countries are listed as under:

Country's tax authorities

Data analytics performed

Australian Tax Office (Australia)

Has been analysing cash transactions of many businesses using its data matching programme.

Her Majesty's Revenue and Customs (UK)

Uses a system called 'Connect' that cross references businesses and people's tax records - identifies links such as family relationships, business relationships, etc.

Although, the initiative of Digital India is a success, the small businesses still use the traditional means of doing business. In line with the 'Digital India' initiative the Government may consider making mandatory the use of 'electronic cash registers' which are linked to an online system. This shall enable the tax authorities verify such transactions / get real time data and also help curb cash transactions. This may be initially taken up as a pilot project.

Many countries such as Poland, Mexico, etc. have mandated the use of electronic cash registers.

· Linking of the 'Permanent Account Number' and the 'Aadhaar' may be made more robust. Compliance burden on small taxpayers may be taken into account for this purpose.

. Moderate tax rates will improve tax compliances and increase the tax base.

4. Recommendations of Special Investigation Team (SIT) on black money:

SIT was formed by Central Government in the year 2014 as directed by the Hon'ble Supreme Court. The said panel has been providing anti-black money measures. In year 2018, SIT on black money had provided recommendations listed as under:

· Cap on holding cash should be increased from INR 20,00,000 to INR 1,00,00,000.

· Currently, the provisions of the Act provide that the taxpayer may get back the entire amount seized by paying tax at the rate of 40% as increased by applicable penalty. In this regard, SIT recommended that the entire amount in the possession of the person on whom search and seizure has been initiated at the time of seizure in excess of the said threshold should go to Government's treasury.

The Government may consider adopting the above recommendations.

5. Approved resolution plan under Insolvency and Bankruptcy Code, 2016 ('IBC'):

The provisions of section 115JB of the Act were amended vide Finance Act, 2018 providing relief to those companies facing insolvency proceeding under IBC by allowing such companies to set off carried forward business losses as well as unabsorbed depreciation. The intention of the said amendment was to speed up the genuine take of stressed assets.

Key recommendations:

Although, amendment in the MAT provisions was a welcome move, certain issues from a direct tax standpoint still need to be addressed:

· Exemption may be provided to such companies from the applicability of provisions of section 50C, 50CA and 56(2)(x) of the Act (applicable in case of transfer of specified assets for a consideration less than fair market value).

· Also, adequate clarifications may be provided with respect to debt waived off (including accumulated unpaid interests) which are already exempt under the income tax provisions but may be subjected to tax under the MAT provisions in line with Ind-AS 109.

6. Transfer pricing provisions:

Key recommendations:

· Currently, the 'Arms' Length Range' ('range concept') ranges from 35 percent to 65 percent which is narrow. The Government may consider widening the range to 25 percent - 75 percent (as compared to the present range of 35 percent to 65 percent). Further, having a range different from those accepted adopted across the globe also results into difficulties resolving issues with other jurisdictions. Additionally, this shall also be in line with the international accepted standards.

Further, the range concept is applicable only in case if the number of comparables are more than 6. Considering the challenges that the taxpayers may face in appropriate comparables, it recommended that the cap of 6 may be reduced or done away with. Reference may also be drawn to US transfer pricing laws, whereby the range concept is applicable irrespective of the number of comparable available

· Keeping in mind the ease of doing business initiative, the Government may increase the threshold of INR 1,00,00,000 for maintaining transfer pricing documentation to INR 2,00,00,000.

· Steps may be taken to reconcile conflicting objectives of transfer pricing for Custom Duty Valuation v. Income tax provisions.

· Currently, transfer pricing assessment is carried on a yearly basis. Considering the fact that transactions undertaken by the taxpayers with its associated enterprises more or less remain same, the Government may consider adopting block assessment (say for instance TP assessment for a block of 3-5 years). Alternatively, there should not be yearly scrutinises. This should be subject to conditions such as - no substantial change in the organizational structure, functional, assets and risk analysis, etc. Further, this would substantially save time and cost of both the taxpayer as well as the income tax authorities.

7. Tax Administration aspects:

Currently, the assessment proceedings by the Assessing Officer ('AO') are being conducted online. However, the proceedings by the appellate forums are still conducted offline. The 'E- Proceeding' facility was launched in June 2017 on pilot basis with an objective to reduce the interface between department and taxpayers, increase transparency, reduce time and cost involved.

In line with the same, the Government may consider extending the 'E-Proceeding' facilities to first level of appellate authority - i.e. CIT (A). The project may be taken up initially on a pilot basis (i.e. initially to apply to selected taxpayers, covering cases that meet the monetary thresholds, etc.) on lines similar to those adopted at the time 'E-Proceeding' facility was initially launched.

8. International Tax - Concept of Significant Economic Presence ('SEP'):

· Provisions of section 9(1)(i) were amended vide Finance Act, 2018 so as to provide that SEP in India shall also constitute business connection in India. The said amendment was applicable from FY 2018-19 (AY 2019-20).

· The concept of SEP is based on two factors namely - revenue and the number of users. The threshold for 'revenue' and 'number of users' needs to be defined by Central Board of Direct Taxes ('CBDT').

· Further, the concept of SEP has been introduced in line with the BEPS Action 1. In March 2019, the OECD issued a public consultation document inviting the comments of the stakeholders on possible solutions to the tax challenges arising from the digitalisation of the economy. The final report is expected to be issued by April 2020.

· One of the objectives for introducing the concept of SEP as stated in Memorandum to the Finance Bill, 2018 was that it would enable India to negotiate for inclusion of digital presence nexus by way of SEP concept in the Double Tax Avoidance Agreements ('DTAAs').

Key recommendations:

· As discussed above, the Final Report on Action 1 is expected to be issued by April 1, 2020. In order to be in line with the international best practices the CBDT should take into consideration the Final Report whilst drafting the final guidelines / Income Tax Rules. This would enable India to drive a hard bargain in amending its DTAAs.

Further, although the SEP provisions are applicable from AY 2019-20, they currently stand ineffective since the CBDT is yet to issue guidelines / Income Tax Rules with respect to the same. The applicability of the said provisions may be deferred till April 1, 2020.

· Having said that in case the applicability of SEP is not deferred clarification may be provided with respect to critical terms such as - users, revenue, systematic and continuous soliciting, engaging in interaction with such number of users, and through digital means.

Whilst defining the above terms, the Government may seek reference to Public Consultation on the tax challenges of digitalisation (issued by OECD) and the comments received thereby.

· A mechanism needs to be provided for attribution of profits in case non-residents having a SEP in India.

It is worth noting that in April 2019, Committee's draft report was issued by the CBDT on attribution of profits to permanent establishment. The said report lays down mechanism for determining attributable profits in case of digital businesses. As and when the said attribution rules are finalised, the same may be adopted for attribution of profits in case of non-residents having SEP in India.

Further with respect to the said draft report, the Government may consider incorporating the same by way of amending the Income Tax Rules. Since there is process involved in amending the provisions of the Act, a substantial amount of time and efforts of legislative would be required. Whereas, in a case where rules need to be amended, since a delegated power vests in the executive, it might be relatively easier to amend and may also help keep the provisions of the law abreast with changes in the business dynamics.

· The rationale behind introducing the concept of SEP was bring into its tax base, non-residents carrying on business in India through digital means.

However, going by the definition of the term SEP as defined in the Act it appears that it may also cover within its ambit, transactions involving physical goods in case the revenue exceeds the specified thresholds. Thus, a clarification may be provided in this regard.

· Adequate clarifications may also be provided with respect to the manner in which the existing provisions - such as equalisation levy (applicable in case of specified online transactions) as well withholding tax provisions (on royalty with respect to computer software) will apply once SEP is applicable.

9. Income tax - other aspects:

Key recommendations:

· Currently, Companies are liable to pay dividend distribution tax ('DDT') on the distribution of profits. Additionally, dividend up to an amount of INR 10,00,000 is exempt in the hands of the recipient shareholders. Since DDT is not considered as income tax for foreign shareholders, they are generally unable to claim foreign tax credit in their country of residence. It is recommended to consider shifting to the earlier approach wherein dividends were taxed in the hands of the shareholders.

· Alternatively, DDT may be reduced to 10% to boost capital markets.

· Long term capital gains exemption with respect to transfer of listed shares / securities may be reintroduced to boost the capital markets.

· Under the presumptive tax provisions, in case of businesses, 6% of the turnover or gross receipts is to be offered to tax in case such receipts are by way account payee cheques / drafts or electronic clearing system.

However, such benefits are not extended to professionals under section 44ADA. The Government may consider passing on the said benefits to the professionals as well.

· Recognition criteria may be introduced for on-time compliance and honest taxpayers.

Above tax benefits and incentives may lead to reduced tax collections in the interim. However, the same may be recouped by way of widening of tax base, better compliances, increased income tax collections due to increase in GST base, unearthing of black money, etc. in interim and long term. The shortfall and recovery analysis may be done over a period of 3-5 years, including possible impact of New Direct Tax Code ('DTC') to be announced in July 2019.

In summary, this is the first Budget of the new Government and it is imperative that the Finance Minister covers all segments of the economy and provide a path towards boost to the economy and employment generation as well as provide certainly and stability on tax laws.

Introduction      

The high expectations of the corporates from this budget and with limited fiscal space, meeting the plethora of expectations would be a challenging task. The interim budget saw a big push for small and marginal businessperson which form the backbone of Indian economy.. Though there have not been many changes at the corporate tax level, but some significant changes are expected at the personal tax level. The expectations from this budget are rising to bring in reforms aimed at creating a tax and business friendly regime and enhancing foreign investments.

Given the current Indian economic outlook, it will be interesting to see what constitutes top priority areas in the government's agenda to formulate the tax policies. Overall simplicity in doing business, tax relief, simplification of corporate tax procedures, etc. have been a customary demand that corporates want to be met in the Union Budget 2019.

We have now highlighted below, some of the key budget expectations from a perspective of corporate restructuring:

1. Carry forward and Set off of Accumulated Losses in Amalgamation or Merger

Issues

• Currently, Section 72A of the Act allows carry forward of loss and accumulated depreciation in case of amalgamation/ demerger only for a specified class of businesses.
• In all other cases , the accumulated loss and depreciation lapses in case of amalgamation. These strict provisions act as hindrance for the service sector companies.
• Furthermore, Section 72A(2) prescribes stringent conditions about continuity of holding majority of assets by the amalgamating company for at least 2 years prior to transfer and 5 years post transfer by the amalgamated company. It also requires that the amalgamating company should be in the business for at least 3 years prior to the amalgamation.

Recommendations

• The services sector is not only the dominant sector in India's GDP, but has also attracted significant foreign investment flows, contributed significantly to exports as well as provided large-scale employment. Acting as the key driver of India's economic growth, this sector has contributed 54.17% of India's Gross Value Added in 2018-19. Accordingly, the lawmakers should recognize the importance of promoting growth in services sectors and providing incentives therein.
• Considering the same, Section 72A should be amended to allow the benefit of carry forward of losses, pursuant to amalgamation, to all companies irrespective of their line of business.
• In line with the same, the necessary amendments should be made in Section 72(A)(2) and Section 72A(2)(b) as well.

2. Place of Effective Management

As per the guidelines released for determining a company's place of effective management (“POEM”), a company would be considered as resident in India if it is an Indian company, or if the company's key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are in India during the relevant year.

Nowadays, foreign companies are outsourcing their high-end critical functions to India which substantially  contribute to their global value and domestic companies setting up arms outside the country for raising funds or expanding business could now face stringent scrutiny on whether they were being effectively managed from India.

Issues and recommendations

The purpose was to establish certainty in relation to establishing POEM, these guidelines are still subject to varied interpretations. As per CBDT Circular, POEM is not applicable where turnover Is INR 50 crores or less in a financial year.

Therefore, it is recommended that the threshold limits for the applicability of POEM guidelines may be reviewed, as the large corporations with the genuine business operations of over 100 -500 crores in overseas jurisdiction and having corporate headquarters in India are required to create detailed SOP's and management teams to demonstrate that the key commercial and management decisions are taken in India.

3. Clarity on Restriction on Carry Forward and Set off of Business Losses - Section 79

Issue

The extant provisions of section 79 restrict closely held companies from carrying forward and setting off of business losses in case shareholding varies by more than 50 percent in the year in which the loss is considered to be set off vis-à-vis the year in which the loss is incurred. This provision effectively restricts carry forward of genuine business losses in the event of transfer of ownership. Considering, consolidation is the need of the hour for many companies in various sectors, many companies are bound to lose such genuine losses incase of acquisition by larger companies.

Recommendation

It is recommended that clarification should be provided by the Government to settle ambiguity surrounding the issue. Further, it is suggested that the condition of continuous holding of the promoters/investors be relaxed.

4. Transfer of Capital Asset between Holding Company and Subsidiary -Section 47

Issues

• Under Section 47, transfer of a capital asset by holding company to its subsidiary company and vice versa is not regarded as a 'transfer' for the purposes of capital gains if inter-alia, the parent company holds the entire share capital of company.
• In order to carry out business in today's challenging business environment, multilayer corporate structure are created for complying various regulatory and contractual requirements as well as risk ring fencing for lenders.

Recommendation

• It is therefore, suggested that benefits of clause (iv) and (v) of Section 47 may be extended to step down subsidiaries where the parent company holds whole of share capital of such subsidiary directly or through other 100% held subsidiary.

5. Taxability of Genuine Inter-Corporate Loans and Advances as Deemed Dividend

Section 2(22)(e) of the Act includes an advance or loan, to a shareholder having at least a 10% voting-power in a company in which the public are not substantially interested, to the extent the company possesses accumulated profits. Thus, any such payment, is deemed to be dividend. Apart from payment to the shareholder himself, a loan or advance to any concern in which he is a partner or a member, with a beneficial interest of not less than 20% is also considered to be deemed dividend. The object clearly is to prevent tax-avoidance by deeming an advance or loan (which would not be taxable) as dividend which is subject to income tax.

Recommendation

With significant expansion in the Indian economy, corporates are increasingly setting up more subsidiaries and fellow subsidiaries. Owing to the interplay of Section 2(22)(e) the advance / loan given by the holding company to the subsidiary shall be treated as deemed dividend. There should be a carve out for the applicability of these provisions especially in case of inter corporate loans given at an arm's length rate of interest.

6. Conversion of one type of instrument into another- Section 47 (x) and 47 (xb)

Issues

• Section 47(x) and Section 47 (xb) provides that, any transfer by way of debentures, debenture-stock or deposit certificates of a company into shares and any transfer by way of conversion of preference shares into equity shares of the same company, will not be treated as a transfer.
• Section 49(2A) provides that, where a share or debenture in a company, became the property of the taxpayer on such conversion, the cost of acquisition to the taxpayer shall be deemed to be that part of the cost of debenture, debenture-stock or deposit certificates or Preference shares in relation to which such share or debenture was acquired by the taxpayer.
• Here the intent of the legislature was not to tax capital gains arising at the time of conversion since it amounts to conversion of an asset held by a taxpayer from one form to another and transfer is not made to any third party involved.

Recommendations

• Since the compulsorily convertible loans/ ECB have similar characteristics of bonds and debentures, Section 47(x) of the Act should be amended to include cases of conversion of compulsorily convertible loan/ECB into equity shares of the company.
• The Act should be accordingly amended to provide that the period of lending of loan/ EBC should be included for computing the period of holding of equity shares.

7. Transactions without consideration or for inadequate consideration

Issue

• Section 56(2)(x) are anti-abuse provisions intended to curb tax avoidance. The provisions should be applicable only to the transactions liable to tax and not on transactions exempted under Section 47. Thus, this section should only be applicable to receipt of assets which are not covered under Section 47 namely:

     -   Section 47(xiii): transfer of asset on conversion of partnership into company;

     -   Section 47(xiiib): transfer of asset on conversion of company into LLP;

     -   Section 47(xiv): transfer of asset on conversion of sole proprietorship into company;

However, in case of nil consideration or inadequate consideration, the above transactions are taxable in the hands of recipient under Section 56(2)(x).

Recommendations

• India is witnessing an upward moving trend in company registrations and conversion of traditional unlimited proprietorships and partnerships to the companies giving it a sought-after status in the Indian corporate scenario

• In order to reduce genuine hardship on such bonafide conversions, Section 56(2)(x) should be suitably amended to exclude these transactions from its ambit.

A reformist budget and big growth plans is the need of the hour. With the ongoing NBFC crisis, there is slow down in the consumption sector and as well as the economy, various sectors are facing growth challenges. Many Indian companies are looking at divestures of their non-core assets to focus on the core businesses. With stability in the government, it is expected that the coming years would have high PE and VC investments in India. Therefore, stability in the M&A policy would spur future growth.

With inputs from Damini Dhull and Manasvi Gupta.

It is usual for taxpayers to expect monetary concessions each time a union budget is presented. Perhaps, the other common expectation, not just by taxpayers but also by all other stakeholders like investors and larger society in general, is to have a greater degree of certainty in tax laws. Tax certainty is critical to stimulate economic development and, in turn, job creation, something that the new finance minister should take a good note of while presenting her maiden budget.

Speaking about certainty, taxes are inevitable and often referred to as the only certainty like death. Now, there is a kind of tax on death itself popularly referred to as the 'death tax'. Such tax can be on the estate (estate tax) or the inheritor (inheritance tax). While in relation to estate tax, the deceased's estate pays the tax before the assets can be transferred to the beneficiary. With inheritance tax, the person who inherits the assets pays the tax.

Estate duty or inheritance tax in some form is prevalent in developed economies like US, UK, Japan and several others. Even in such countries, such taxes typically meet a lot of criticism due to the fact the taxes have already been imposed on the income which helped creation of the assets that devolve on death.

When it comes to measuring inequality in the world, India scores very high and ranks second. There is a view that suggest that death taxes can reduce inequality of income, although there is not much empirical evidence to support this hypothesis. The gap between the richest people in society and everyone else is unfortunately on the rise and this has severe social ramifications. As per Credit Suisse Global Wealth Report of 2018, the richest 10% of Indians own 77.4% of the country's wealth out of which richest 1% owns 51.5%.  According to World Inequality Report 2018, India is among those countries where income inequality has increased more rapidly. Every year rich people are getting richer at a much faster rate than the humble and unprivileged. UK-based charity Oxfam International's has ranked India among the bottom 10 countries (147th rank out of total of 157 countries) in a new worldwide index 'Commitment to Reducing Inequality (CRI) Index' released in 2018 on the commitment of different nations to reduce inequalities in their populations.

All the above data and statistics clearly indicate some urgent action. This moot question is that can this be done by way of tax reforms? Data in isolation may prompt development of tax policies which may not only raise revenue but also redistribute wealth, which brings with it a possibility of re-introduction of estate taxes in India.  

Inheritance tax - history in India

India had introduced inheritance tax in 1953 and the tax rate at a point of time was set as high as 85%. However, this estate tax was abolished in 1985. One of the important factors that led to its failure was lower yield from the estate tax compared to its cost of administration and low recovery of taxes in absence of adequate infrastructure for dissemination of information and financial data available with the government for valuing assets etc.  

We also had Gift Tax Act, 1958 wherein the gifts received from nonrelatives were made taxable. This Gift Tax also got abolished in 1988 and finally in 2004, the concept to tax gifts was again introduced, with a new provision in the Income Tax Act 1961 under Section 56 (2).  Here again, there is an exemption, without any monetary thresholds, for receipts of gifts from relatives. The income tax law also specifically provides an exclusion for transfer of asset under a will or inheritance from the purview of gift taxation and capital gain tax. As a result, presently any transfer of assets through testamentary or intestate succession, is not subject to any tax which may be expanding the inequality further.

Does India need estate taxes to be re-introduced

Though the estate duty / inheritance tax was axed in 1985, but the word of its revival has been in the air since 2014 when the minister of state for finance had expressed views about a possible levy to help in levelling the income inequalities. Furthermore, with the abolition of tax on wealth and the specific amendments in 2017 exempting transfer of assets to family trusts have somewhere left second guessing that the estate duty may be reintroduced, since the government has tacitly allowed ample time for taxpayers to plan their affairs and wealth ownership.  Taking cue from these measures, several of high net worth families (HNIs) may have already taken steps to plan for such taxes in the last couple of years.

The move to tax the HNIs at progressively higher rates can also be seen by the change introduced in the last four years providing for a higher surcharge rate for taxpayers earning income more than INR 1 Crore and an additional 10% tax on tax free dividend incomes exceeding INR 10 lacs. Progressive rates can help to reduce the income inequality to an extent but from a practical perspective may not be enough to reduce the wealth inequality. Thus, political circles are now tempted to think about an idea of bringing about a resurgence of estate taxes in India as they view it as a viable instrument not just against rising wealth inequality and but also bolstering revenues.

Conversely, the risk with re-introducing such taxes is that it can potentially reduce wealth accumulation and induce aggressive tax avoidance strategies that might cause a flight of wealth outside the country. It is natural that any such levy is met with hostility mainly because it will be imposed at a time of sorrow and on the assets on which the deceased had already paid tax, a kind of double taxation. There is also a fear of inconsistent and coercive administration to recover such taxes and disputes linked to valuation basis and methodology. In many countries, estate taxes have caused a forced sale of businesses or even bankruptcy. Such taxes tend to discourage domestic entrepreneurship, impacting investment and employment and consequently economic growth.

Nevertheless, it remains as a tax policy tool to address the glaring income inequalities in India and if at all introduced needs to be customized to address the social and cultural requirements of Indians. Any estate tax levy should provide a sufficiently high threshold that is meaningful in the present context and does not disincentivize wealth creation. The rate should be moderate to ensure that there is no widespread evasion or disputes and protracted litigation. In addition, such tax deposit obligation on the inheritors should permit a deferral with enough time provided to the inheritors to pay the tax gradually so that there are no distress sales of assets or business.  Finally, the tax rules should incorporate an explicit regime to recognise family trusts and permit their legitimate usage to plan for inheritance tax.

Conclusion

Inheritance tax may prove to be a double whammy for the rich. The fact that they are already subjected to the highest tax rates, it may be unfair to further levy a new tax on wealth created out of their tax paid earnings.

To boost its fiscal revenues, it is imperative for the government to increase the existing tax base. With the advent of collaboration between various transaction & tax databases, tax technologies can be effectively deployed to add new revenue sources & cover additional taxpayers.

In case the government still plans to re-introduce inherence tax, it clearly needs to do a fine balancing in defining the rules for its imposition & collection. The rate of inheritance tax should be moderate so that it does not entice tax avoidance. The taxman also needs to come up with rational threshold limits & clear rules on exemptions from its levy. Lastly, it is also important to address the liquidity and the time period for the inheritors to deposit the tax. Inherently, this is quite a difficult task in the hands on the new finance minister and we all hope for a momentous budget to be announced by her on July 05, 2019.

With inputs from Anant Jain, Director BDO India LLP

As the finance minister works to present the first union budget of Modi government 2.0 on 05 July, the market is abuzz with speculations on whether she would announce some big-bang changes or would take measured steps. On the tax front, with the introduction of GST, the budget proposals are going to be largely around direct taxes. The big question is whether the government would bring any significant changes in the income-tax act, given that the Direct Tax Code (DTC) is on the anvil.

Over the past five years, the government's approach to change in tax law has largely been consultative. The government has issued a host of clarifications, guidelines and circulars after due stakeholder consultation. This has made the changes more acceptable to the industry and helped the government remove/address irritants in the proposal before it is implemented. Going by this trend, one can expect big-bang changes to wait for DTC, which is expected to undergo a consultation process very soon.

The finance ministry of the Modi government 1.0 worked largely around the agenda of preventing tax avoidance, reducing litigation and promotion of high priority sectors. One would expect this agenda to continue in the current government as well.

The government took a slew of measures such as the introduction of the black money act, amendment in benami property law, changes in the income-tax law to strengthen anti-abuse provisions. Still, there remains some areas, such as write-off of loans and advances by the borrower, slump exchange, lower tax rate for inbound dividends etc. which can see some curbs being imposed in the Budget.

On reduction of litigation, several clarificatory amendments were made based on the recommendations of the Justice Easwar committee. The committee's second report has also been sent to the government, so one can expect that some of the troubled areas like broad-brush application of section 56 on issue/transfer of shares would get addressed.

The tax law has been used by several governments in past as a tool to promote key industry sectors, the focus of this government has been employment generating sectors like start-ups and infrastructure. Even the concerned ministries have been quite proactive in addressing the concerns of industry. A most prominent example of this is the angel tax exemption granted to start-ups, where the challenges faced by the start-up community have been taken up the Department for Promotion of Industry and Internal Trade (DPIIT) with the Central Board of Direct Taxes (CBDT). While the laid down policy of the government is to move away from granting tax incentives, one can still expect some benefits for the promotion of employment generation and low-income housing sector.

One question that crops up every budget is the reduction of the corporate tax rate. Several developed economies have reduced their headline corporate tax rates to attract/retain investments. On similar lines, the Indian industry has also been demanding competitive tax rates. However, considering that the FM is walking the tight rope of falling tax revenues and maintaining fiscal deficit, one can expect that this demand would be given a pass in the upcoming budget.

Another area which is most watched out for is individual tax rates. The government has come back with a significant majority and as a measure to thank its voter base, one can expect a symbolic benefit being extended to individuals, which might in the form of higher rebate or benefits for investments. The government is against increasing the minimum tax slab, as it throws out a large part of the taxpayers out of the tax ambit.

Also, every year there is contemplation that the government would revive estate duty on high net worth individuals. While a large part of Indian HNI group has already undergone estate planning and may not be really impacted if the estate duty were to return. Thus, the government would have to evaluate the cost-benefit of reintroducing estate duty, especially in light of the fact that wealth tax was abolished recently as it did not result in adequate tax collections. It is likely that this changed would be parked for further evaluation and may be left to be introduced by the DTC.

On the market front, there is speculation of an increase in long term capital gains tax rate on traded securities to bring in tax rate parity between transfer of listed and unlisted securities. Considering STT is levied on on-market transactions, one can expect the tax rate can go up from 10% to say 15%. Also, there has been a debate on the removal of Dividend Distribution Tax and reversal to the earlier regime of taxation of dividends in the hands of shareholders. This helps foreign investors in taking tax credits in their home jurisdiction and domestic investors in getting out of the ambit of section 14A disallowance. This would be a major change and one can expect it to be introduced through the DTC.

While the finance minister is new on board, there is continuity at the administrative level and the overall government's philosophy. Thus, one can expect the tax changes would go in the flow of the government's agenda of curbing tax avoidance and promoting ease of doing business!

The first full-fledged Union Budget of the government, now in its second term, is scheduled to be tabled in the Parliament on July 5, 2019.  As usual, expectations from the Union Budget remain high. International investors, especially Foreign Portfolio Investors (FPIs) will be hoping that the government will continue to focus on creating a non-adversarial tax regime in India. 

In particular, FPIs will be hoping that the government will consider laying to rest (retroactively) the controversy on offset of short-term capital losses (STCLs) on transactions that have been subjected to Securities Transaction Tax (STT), against short-term capital gains (STCGs) arising on capital assets that have not been subjected to STT. In fact, this issue is not isolated to cases involving only FPIs; it extends to any taxpayer who earns STCGs/STCLs from both: STT paid as well as non-STT paid transactions in Indian capital assets.

What does the tax law say?

The Indian Income-tax Act, 1961 (Act) prescribes different tax rates for STCGs/STCLs arising from transactions in equity shares, units of an equity-oriented fund and units of business trusts, which have been subjected to STT.  STT is levied on certain transactions that have been implemented via the Indian bourses. Such STCGs are taxed at a concessional tax rate of 15 percent as per section 111A of the Act. However, STCGs/STCLs arising on non-STT paid transactions (e.g. transactions in derivatives, off-market open offers etc.) are taxed at a higher rate of 30-40 percent under the normal provisions of the Act. 

Further, section 70 of the Act states that a taxpayer is “entitled to, inter-alia, offset any STCLs against STCGs arrived at under a “similar computation” during a financial year (FY).  If the STCLs are not utilised during a financial year, they can be carried-forward and offset against any future capital gains, whether STCGs or long-term capital gains (LTCGs), as per section 74 of the Act. In fact, section 74 of the Act does not even mandate that the STCLs should be arrived at under a “similar computation” to allow an offset of the STCLs, unlike the wordings in section 70 of the Act.

Interestingly, the tax law does not prescribe the order or manner in which STCLs may be set-off against STCGs or LTCGs. In 2002, the legislature had specifically amended the Act to restrict the offset of long-term capital losses (LTCLs) only against LTCGs and not against STCGs. However, a similar restriction has not been introduced in the Act for STCLs. 

Given that, many taxpayers, including FPIs, choose to first offset STCLs (STT paid) against STCGs (non-STT paid), which reduces their overall tax outflow, the remaining STCLs (STT paid) are then offset against STCGs (STT paid). Such a tax position is well within the contours of the tax law and in line with the interpretation of Indian courts on the matter. Further, it is a well settled principle in tax law that a taxpayer is free to adopt a tax position that is more beneficial in its case, unless such a tax position results in misuse or abuse of the tax law, which is clearly not the case here.

What do Indian tax authorities say?

Indian tax authorities have a different view on the matter. Over the last few years, some tax authorities, at the tax assessment stage, have not allowed the offset of STCLs on STT paid transactions (whether realised in the same FY or brought-forward from earlier FYs) against STCGs from non-STT paid transactions. The argument of the tax authorities is that STT paid and non-STT paid transactions are two different sets of transactions which are subject to different tax rates; that the method of computation for both sets of transactions is different. Tax authorities have adopted such a stand despite rulings on the subject by the Mumbai Income-tax Appellate Tribunal (ITAT), which are in favour of taxpayers.

What do Indian courts say?

The Mumbai ITAT first ruled on this issue in 2009 in the case of First State Investment (Hong Kong) Ltd (33 SOT 26) [which was registered as a FPI], in favour of the taxpayer, i.e. it allowed the offset of STCLs (STT paid) against STCGs (non-STT paid). The ITAT surmised that STT paid and non-STT paid transactions are computed in the same manner; the computation mechanism cannot be confused with the rate of tax that may apply to certain specific transactions; that a taxpayer was vested with the discretion to offset STCLs from one transaction against any other STCG. There have been a plethora of rulings by the Mumbai ITAT on the same issue in case of other FPIs thereafter - all in favour of the taxpayer. 

Indian tax authorities have filed an appeal on the issue with the Bombay High Court in case of some FPIs, which is currently pending adjudication.

Closing remarks

Over the last five years, the government has made a discernible attempt to address anomalies in the tax law that have impacted taxpayers, including FPIs. Any relief that the government provides on the issue of offset of STCLs is likely to be welcomed by taxpayers, especially FPIs.

The article is co-authored by Hemant Vaishnav (Deputy Manager, Deloitte India)

Views expressed are personal. The tax rates in the article do not take into account surcharge, and Health and Education Cess which may apply over and above the base tax rate.

Recent NBFC crisis and downgrading of corporate bonds have affected several mutual funds that invest in debt securities. Interestingly fund houses have reacted very differently. Many are writing down defaulting papers. Some have deferred repayment of maturity proceeds of their fixed maturity plans. One of HDFC mutual fund's debt schemes sold its affected securities to its AMC thereby protecting investors. Kotak repaid its investors after deducting maturity proceeds attributed to defaulting investments. HDFC MF renewed one of its fixed maturity plans by 12 months.

Earlier this month Tata Mutual Fund, house split its portfolio into two in one of its debt funds. The trigger was a default of interest payment by DHFL an NBFC in news for its troubles these days. Tata mutual fund is the only mutual fund that has made a first formal use of circular issued by SEBI in December 2018. JP Morgan had of course done it some years ago after Amtek default, leading to SEBI formalising and standardising the process to put checks and balances in the interest of investor protection.

SEBI circular dealing with a mechanism known as 'side-pocketing' mechanism allow a mutual fund to segregate the downgraded or bad debt securities from the investment grade securities into a separate scheme with a separate Net Asset Value (NAV). Investors are allotted new units for the new portfolio and as a result the NAV of original units is revised. While the transactions of investments and redemptions or sale continue in the original units, no transactions are allowed in the units of new portfolio till recoveries are made from defaulting companies. However such units are required to be listed to facilitate exit by investors in secondary market, though it is unlikely that much trading will take place in such units.

The scheme as such serves a very meaningful purpose for investors. If the bad portfolio and units are not segregated, then the moment a credit default happens and hence the write-off happens, the NAV goes down and any investor exiting at that NAV will lose the chance of benefit of recovery. If fresh investors come in at written down NAV and then the recovery happens, the new investors gain at the cost of existing investors. Also till the NAV is written down while bad debt is among the portfolio the trading is effectively happening at a 'wrong' NAV which not be truly reflective of units worth. One hopes that in coming months more fund houses follow Tata group in adopting good practices in interest of investors

To give an example of side pocketing, let's say an investor is holding 1000 units bought at Rs 10 each with a total investment of Rs 10,000 with the current value of Rs 15,000 at the NAV of Rs.15 each. If the exposure of bad debt is say 20%, and a 50% write down of such debt is done (SEBI circular mandates 75% write down), the side pocketing or segregation would be done for portfolio of Rs 3,000 carried forward at written down value of Rs 1,500 i.e. NAV of Rs 1.5 per unit. Original units will have a new revised NAV of Rs 12, with investment worth Rs 12,000. Without side pocketing, all the units would carry a NAV of RS 13.5 and investment valued at Rs.13,500.

Looking at the scale of defaults and the large number of mutual funds having exposure of bad debt paper, it is likely that SEBI will push for better adoption of side pocketing mechanism. Hence it is important to examine if current tax provisions are adequate or any special concessions need to be made. 

As such the investors can chose to sell/redeem the original units at any time.  They are likely to hold new units till some recovery is made from defaulters. On sale/redemption of either category of units there can be gain or loss for the investor. In case of non-resident investors, the mutual fund is expected to deduct tax before make payment of redemption amount. For all resident investors also the mutual funds are required to provide capital gains statement for paying taxes filing their tax returns. Hence the fund house also needs to change their systems to do appropriate calculations of capital gains. For these purposes the investors and mutual funds need to determine the cost of purchase of original and new units for tax purposes..    

Applying a common sense or a commercial approach, broadly there can be two methods - one where no cost is attributed to new units and the other where cost is allocated to original and new units on some basis.

While there is no specific provision that deals with side pocketing, section 55(2)(aa) of Income tax Act, 1961 appears to be closest to deal with the situation. It provides that when on the basis of any financial asset an additional financial asset is allotted to a person without any payment, then for original asset the actual cost should be adopted and for the additional financial asset the cost should be taken as nil. The period of holding of new asset is calculated from the date of allotment of new asset. This provision is often used in the situations of issue of bonus shares. Applying the provision one could simply calculate the tax by deducting entire cost from sale/redemption proceeds of original units, and nothing from redemption proceeds of new units. One can then apply short term or long term capital gains tax on the units taking date of allotment of new units as basis for period of holding of new units.

Further section 94(8) provides that where any person is allotted additional units without any payment on the basis of original units and such person sells original units within a specified timeframe, the loss if any arising on account of such sale shall be ignored and that loss shall be deemed to be the cost of purchase additional units.

Would this mode of adopting cost and calculating gains on original and new units be fair to investors? Similarly, would ignoring loss on original shares be fair if it falls within specified parameters?

It would probably depend on what investors chose to do in terms of priority of exit from original and new portfolio/units. If an investor choses to sell the original units first, the aforesaid provision is beneficial because it allows for deduction of entire cost. If however an investor happens to sell new units first and it happens to be a short term gain which attracts higher tax, one would want to deduct some proportionate cost from such gains because as a matter of fact it is not that units were allotted as a gift, a part of the cost actually was effectively paid towards such units. Further commercially the investor may be making loss on the transaction because the recovery of bad debt may be lower than 100% or even lower than the written down NAV and hence taxing such an investor on entire proceeds would be grossly unfair. In the worst possible scenario of no recovery at all, the investment (new units) may have to be written off, the loss would not even be counted for tax purposes because there would be no transfer of units.

Hence in author's view this situation should be compared with a case of a corporate demerger. In a corporate demerger the original cost of shares is allocated over original and new share, based on net-worth of the two businesses which are split. In the mutual fund industry, perhaps the NAV is closest to the concept of networth of a company's business units and hence a fair allocation of cost could be on the basis of two NAVs, the NAV of original units post side pocketing and the NAV of new units. SEBI regulations do not mention anything about face value of new units probably because it is irrelevant from investor's angle. So face value as a basis of allocation is anyway not available. Therefore, NAV appears to be most logical and fair basis of allocating original cost.

If this method is given legal sanctity, the numbers would look as illustrated here. Carrying forward the aforesaid example, lets us assume that an investor makes an investment of Rs 10,000 on 1000 units and the current value/NAV is RS 15,000 @  Rs 15 per unit. If such a portfolio had a bad portfolio of pre-write-down value of Rs 3,000, on segregation of bad portfolio, the revised NAV of good portfolio would be Rs 12 (12000 / 1000). If the bad portfolio is written down by 50% (though sebi mandates 75% write-down), the new units would have a NAV of Rs 1.5 (50% of 3000 / 1000).  The cost of RS 10,000 will have to split in the ratio of 12 to 1.5 which works out to Rs 8,889 and 1,111. Accordingly the capital gains would need to be calculated and the period of holding for short or long term gains would be determined from the date of purchase of original units for both categories of units.  

It can make a substantial difference for investors depending on how calculations are made, apart from the complications in a situation where investor ends up with a loss on original or new units as discussed earlier. Given that the number of mutual funds with exposure to bad debt paper and the investors affected are huge, we are likely to see more instances of side pocketing; the new budget proposals must introduce provisions to deal with the situation. The mechanism covered by SEBI circular should be treated at par with a corporate demerger. Also, in the worst case of no recovery at on, write off of new units should result in a tax loss that can be adjusted against other gains of investor even if there is no transfer of units. Further, a carve out needs to be made in Section 94(8) which effectively restricts set off loss on original units against other gains under certain circumstances. A carve out is needed because unlike in bonus units or bonus shares, the loss on original units is not because of additional issue bonus issue but because of genuine reduction in intrinsic value of underlying original portfolio along with a possible dip in the value of new units as well. One hope these issues are addressed appropriately in the finance bill to be presented next week.

The Insolvency Bankruptcy Code, 2016 (“IBC” or “Code”) is indeed one of the most successful reform successfully implemented in India. IBC was enacted as a one stop solution for resolving insolvency, recovery of debt claims, to strengthen the ease of doing business in India, etc. Like any other new law, IBC regulations have evolved based on experience during the last 3 years. There have been few amendments to the law and landmark judgements clarifying and settling the dust on contentious issues (such as status of home buyers as creditors in IBC process, protection of interest of operational creditors from substantial hair-cut, etc.).

As per the world bank data[1], India stands at 77th position in ease of doing business wherein resolving insolvency is one of parameters considered out of total 10 parameters. Per this report, India stands at 108th position in resolving the insolvency cases out of total pool of 190 countries. Perhaps, being a newly enacted legislation, the success of IBC was too early to be seen in the rankings and hopefully this will improve drastically in the coming years rankings. The success and importance of IBC can be measured by the fact that the recovery rate under IBC has been much higher than the recovery under other laws such as DRT, Lok Adalat and SARFAESI Act.

A clear process under the IBC framework is one of the key drivers to ensure faster resolution and resultant higher  recovery. The new RBI circular of June 07, 2019 is also aimed at facilitating resolution in a time bound manner  with early recognition of stress and a great deal of discretion of lenders to determine a resolution plan.

Income-tax Act, 1961 (“IT Act”) as a federal legislation has an important bearing on revival of stressed assets. IT Act can serve as an enabler and catalyst to achieve a faster resolution of stressed assets and consequent boost to the economy.  While an attempt has been made to provide some benefits and clarity in the Income-tax Act, 1961 (“IT Act”), a lot remains to be done to make the entire resolution process seamless and tax neutral for all stakeholders.

The top three issues that can be addressed by the new Finance Minister in her maiden budget to bring in cheer and facilitate resolution of stressed assets in our country.

1.       Carry forward of losses due to change in ownership or amalgamation 

Most resolution process will result in an unrelated resolution applicant becoming the dominant shareholder of the stressed target company. A change in beneficial shareholding of a closely held company beyond 49% leads to lapse of  tax losses (except unabsorbed depreciation) as per Section 79 of the IT Act. 

In respect of resolution plans approved under IBC, Section 79 of the IT Act was amended vide Finance Act 2018 and allowed the carry forward of tax loses after affording a reasonable opportunity of being heard to jurisdictional Principle Commissioner or Commissioner. This provision leads to uncertainty and subjectivity in absence of clear guidelines in terms of timing for such opportunity (whether before or after the approval by NCLT), time period available to Principle Commissioner or Commissioner and the parameters to be considered by Principle Commissioner or Commissioner to accord its approval for resolution plan.

The forthcoming budget should not only provide clear guidelines on the above but also extend this benefit to subsidiary companies of the target. More importantly, given that the new RBI circular does not make it mandatory for banks to refer cases to IBC for resolution, in coming years there will be more instances of resolution plans approved outside of IBC and thus the need to provide similar benefit to such cases.  Furthermore, conditions specified under section 72A for carry forward of losses in case of amalgamation of insolvent company may prove to be cumbersome for reviving of such insolvent company through amalgamation and these provisions deserve to be liberalized in view of changed circumstances.

2.       Write back of loan (including interest) and other debt and claims

It is common to have banks & other creditors agree to a hair-cut for successful resolution. Such waiver or write back for accounting purpose is normally credited by the borrower to the Profit & Loss (P&L) account.

Section 41 of the IT Act provides for taxability upon cessation of a trading liability for which a deduction has been claimed in the past years. Moreover, there are MAT implications in respect of other loans and claims that are credited to the P&L account. The IT Act should specifically carve-out resolution cases from the applicability of Section 41 and for MAT purposes.

3.       Deemed income as per valuation norms for shares applicable under section 56(2)(x) and 50CA

Both these provisions in the Act were introduce as anti-abuse provisions to discourage the transactions entered to avoid tax and as a curb to generate black money. Any transfer of shares of an insolvent company as part of a resolution process, irrespective of the price or value should not give rise to any deemed income in the hands of the seller or acquirer. This will help bring clarity in the tax treatment as well as help in reducing litigation.

Disclaimer: Views expressed are personal

This Article has been co-authored by CA Anant Jain (Director, BDO India LLP) and CA Shivam Pandey

The new Modi 2.0 Government is in place and already in action.  The new Finance Minister of India, Smt. Nirmala Sitharaman ('Hon'ble FM') already has her task cut down with slowing economic growth, slowing consumer demand, slow investment growth, high unemployment and of course low revenue growth.  All eyes will now be on the first budget scheduled on July 5, which can lay out a road map for the future.  This macroeconomic paradigm is also expected to cast a shadow on the fiscal proposals in the Budget.  Some of the key aspects that we expect could feature in the budget proposals are as follows:

For the common man, spur consumption

After the emphatic win for the Government, there could be a celebratory feel good for the common man, which could also translate into increased consumption spending in the short term.  This could take the form of some minor tinkering with the slabs, or more likely increased limits for deductions linked to investments or even housing loans.  This would also have a positive impact on the real estate sector, which can give some fillip to employment generation.  There was already some changes in the interim budget earlier in the year, but it could continue. 

Impetus to investments

With the ongoing US China trade war, the Hon'ble FM could introduce some tax incentives to attract US investors who may be considering moving away from China.  India would compete with other countries in South East Asia for these investments and hence could consider sweetening the deal for investors with some incentives.  While, in the last 5 years, as per the stated policy of the Government, they have been moving away from tax incentives and holidays, the prize here could be large and attractive and may motivate them to make an exception.  Such incentives could take many forms.  It could be a plain vanilla tax holiday under Chapter VIA.  It could also take the form of new industrial or economic zones which could have fiscal incentives.  The challenge for such zones, like in the case of SEZ's in the past, of course is land availability, given that land is an emotional and political subject.    

Insolvency and bankruptcy code ('IBC'), credit growth

IBC has made progress in the last few years and is increasing, both, the speed of resolution of bad loans as well as the recoveries on the same.  Of course, there are flaws which need to be ironed out.  One of the issues in the process is the tax arising on investments made by the investors in the insolvent entity.  Such investment, which could be lower or higher than the FMV of the entity (determined as per conventional valuation methods), because, it is almost a competitive bid situation, could result in tax implications for the investor or the investee entity under section 56(2) of the Income-tax Act as income from other sources.  If this creates a tax liability, it puts pressure on the resolution process.  The Government could address this concern, given the critical need for the IBC process to succeed, because of the NPA issues that banks are facing.  

Digital taxation, revenue augmentation

India played a key role in the BEPS project of the OECD and was instrumental in several of the far reaching changes that have emanated from the same, in the global fight against aggressive tax planning.  Continuing the posture, India has been playing a key role in the OECD as well as the G20 and other international forums, on taxation of the Digital businesses.  India's proposal on a formulary based profit attribution, with users and market as a key criteria for the allocation, seems to have had an influence on the alternate proposals being considered for the OECD Inclusive Framework approach.  Even on the domestic front, India has been active in proposing several unilateral measures such as Equalization Levy, Significant Economic Presence ('SEP') and most recently, new attribution rules (mentioned above).  This trend could continue in the budget and we could see some proposals on the above areas.  It could be unveiling the revenue, users or transaction criteria for SEP, a road-map for the profit attribution approach or an expansion of the list of activities subject to Equalization Levy.  We would request the government to tread cautiously in this area since the global consensus is yet to emerge, and any change, being unilateral in nature, will likely result in double taxation, and hence may be detrimental to the sector.

Inheritance Tax, political statement

Some quarters are suggesting that the Government could also be considering an Inheritance Tax.  This would of course be a great political statement, impacting the rich while sparing the not-so-rich, but its possible impact on actual revenue collection may not be material.  The experience with similar taxes in other parts of the world has not been very encouraging, since the collections from the same are quite limited.  Hence, any such move should be based on strong empirical basis to establish the basis, to avoid the fate of Wealth Tax.

While the above lays out some of the expectations from the Budget, we could not leave this opportunity to also talk about a wish list, which should be considered for a more medium term view on tax policy.  This could possibly be considered in the DTC which is under preparation.  The four key prongs that we would desire for in a New (Tax) Deal:

Rational Tax Rates

Corporate Tax rates in India (including the DDT), on a fully distributed basis, are amongst the highest in the world at ~ 46%+.  This does not augur well for attracting investments in a competitive world, where capital is scarce and several countries are competing for the same.    On the other side, personal tax rates, at the higher income levels could be increased.  The personal tax rates in India, at the high income levels (@ ~ 35%) are fairly low, compared to the world average.

Improved tax administration

An aggressive tax administration, which earns us epithets such as tax terrorism, is the other key area that needs redressal.  The key reason for the same is the almost uni-dimensional measurement of the Revenue officers based on revenue collections on the one end and increasing empowerment of the officers, without sufficient accountability.  This skew also needs to be addressed.   

Tax certainty

Most businesses and companies, would desire tax certainty, instead of ambiguity.  It is equally true, that in the complex world we live in, the tax law cannot possibly be comprehensive enough to address all possible ambiguity.  Accordingly, we need a robust and independent advance ruling process, like in all advanced countries.  Our existing process is slow and does not address the needs of business.  The other element is the proliferating disputes and the long and arduous dispute resolution process.  The Government could consider a settlement scheme where taxpayers and authorities can sit across the table and resolve differences and even settle taxes, like a commercial negotiation.  This would require lots of discretion to officers, and hence would warrant strong safe guards.

Expanded tax base

Many of the short comings in our existing tax system, is due to the small tax base that we have.  The small tax base, constrains the Government to undertake any bold reforms, for fear of losing its existing base.  Hence, there is a need to expand the base.  In our view, the expansion requires, bringing large swathes of the parallel economy, within the tax net.  Digitization and data analytics has to be the tool used to identify such areas and bring them into the tax net. 

It is understandable that the above is difficult to achieve in the short run, but the Hon'ble FM could lay out a path ahead, a vision, which can incorporate some of the above elements and move us to a tax system, which keeps pace with our aspirations to be a high growth economy to reach the $ 5 Trn vision of the Government.

While the global economy is battling with strong headwinds, India's economy is seeing a robust growth and is on the path to emerging as one of the fastest growing economies in the world.

Over the past few years, the economies of solar power has improved in India. India's installed solar generation capacity has grown over ten times in last five years. It's a far more cost-competitive source of electricity generation than it was a decade back or more. The sharp decline witnessed in the module and installation cost of the solar photovoltaic systems in the country and all across the globe has been a significant reason for such a development, and have also pulled up the solar power capacities higher than before.

The year 2018 was a tumultuous one for the solar industry. Vague interpretation of the GST rates led to a long period of confusion which in turn delayed many projects. Imposition of safeguard duty in the middle of the year led to many legal battles and increased the costs of solar projects. More so cancellation of many auctions by state agencies amid such uncertainties also hampered the confidence of solar developers in the Government.

Presently, India boasts a solar power installed capacity of 24 GW, with a target of 175 GW of renewable energy by 2022 - a goal which was set by the NDA Government in the beginning of its five-year term.

Talking about consumption, a new demand segment for solar power is picking up i.e. solar rooftops. Good number of companies especially the PSUs with large physical footprints and high power costs are switching towards installing commercial scale rooftop solar systems, often at less than the current price of buying power from a distribution company (DISCOMS). Also, for the industrial belts where power requirement is massive and congestion in the transmission lines is also high, rooftop systems can be utilized to get some respite.

The interim budget announced in February 2019 did not bring much cheer for the Indian solar energy sector. The sector has mixed expectations from the upcoming budget and is hoping that this year's budget will pave the way for achieving the ambitious solar targets agreed upon and that the Government will provide level-playing-field to solar developers.

The sector hopes for various reforms in the form of tax incentives and increased allocation of Government fund towards the sector.  This will help propel the sector towards a sustained growth path for the long-term. Some of the expectations are highlighted below:

• Lowering of interest rates and providing attractive long term financing options for development of renewable power assets. This would give a boost to the sector and Government's target of achieving 175 GW of renewable energy by 2022;
• Inclusion of solar power equipment manufacturing under priority sector lending. As per RBI circular dated May 10, 2018, 'Revised guidelines on lending to Priority Sector for Primary (Urban) Co-operative Banks (UCBs)', the option of a bank loan upto a limit of INR 15 crores is available for the purpose of solar based power generators. On similar lines, solar power equipment manufacturing should also be included in the head renewable energy under priority sector lending.
• Allocation of Special Fund for EV battery system;
• Increase in allocation of Government spending for Ministry of New and Renewable Energy (MNRE) and Solar Energy Corporation of India (SECI) to enable solar power capacity growth;
• promoting domestic solar panels' manufacturing capacity in order to cut down the current heavy reliance on cheaper Chinese imports;
• Promoting Research & Development for solar power projects and providing funding as well as tax incentives. Introduction of weighted deduction of 200% for all spending on R & D;
• The Government should also introduce incentives for floating solar installations to make it a viable business proposition;
• Introducing a policy measures and make it mandatory for all DICOMS or private distribution licensees to synchronize with solar players and treat them as partner;
• Reduction in taxes on renewable energy consumption in order to promote rooftop solar as well as usage in small micro commercial and retail establishments;
• Rationalization of corporates taxes, reduction in MAT, DDT, etc.
• Announcement of tax incentives / tax reduction viz. incentives for solar installation, tax reduction on renewable energy consumption and subsidies for developers in the Union Budget 2019-20 in order to encourage developers to undertake solar projects;
• The present deduction of 100% of profits and gains of business from generation or generation and distribution of power is available if the undertaking begins it operations on or before 31 March 2017. In order to encourage promote renewable energy and achieve the ambitious solar targets, this sun set clause should be extended at least till 31 March 2022;
• At present only companies incorporated under the Companies Act are eligible for 100% profit linked deduction and other entities like LLPs are not eligible for this benefits. The Government has been encouraging LLPs as business model and given that the benefit of profit linked deduction should be extended to LLPs as well;
• The profit linked deduction is not helping the solar sector as these companies are subjected to MAT levy of almost 20%. This effectively neutralizes the tax benefit granted to the sector and in fact it is acting as counterproductive for the desired ambitious growth. The Government should  remove MAT levy for the entire Infrastructure sector including renewable energy sector;
• As per the provision of Section 35AD of the Income Tax Act, 1961, specified businesses are allowed a deduction of 100% on capital expenditure incurred prior to the commencement of operations. The tax benefit provided under Section 35AD to specified businesses in respect of capital expenditure incurred prior to the commencement of operations should be extended to solar developers as well considering the fact that setting up of solar plants involves huge capital outlays;
• Rationalization of GST tax structure to minimize litigations and facilitate ease of business. The present recommendation of GST Council of 70:30 split for 5% and 18% GST should be modified to 90:10 so that the overall GST cost could go down to 5%.

Summing Up

The sector is poised for enormous growth and there are new opportunities ahead for solar energy sector to grow and albeit, there are challenges like- power evacuation and distribution issues, solar equipment cost, importing solar modules and cancellation of projects that are standing in the path to faster solarisation of the country.

Given this scenario, Indian solar power industry had high hopes from 2019 Interim Budget, but it did not addressed the issues of the sector. The sector has high hopes from the Modi Government through the full-fledged Budget address and the stakeholders are hopeful their expectations will be met, given that solar sector has the potential to lead the country towards energy self-reliance, industrial growth, and employment generation. 2019 is bringing new opportunities for solar power growth in India, however realization of these opportunities depends upon prioritizing solar industry and bringing in favourable policies.

The article has been co-authored by Vyomesh Pathak and Nikita Verma(Chartered Accountants).

As the Hon'ble Finance Minister is going to present her first financial bill in the parliament on July 5, 2019, business community especially foreign investors and multinational companies have many expectations in terms of transparency and speedy assessment, to bring certainty in respect of tax provisions, to remove various bottlenecks under the provisions which causes hardship to the taxpayers. The author has summarized few provisions of transfer pricing which should be considered by the Hon'ble FM in upcoming presentation of first finance bill.

1. Thin Capitalization

Issue : Single ratio (i.e. 30% of EBITDA) for allowing interest expenses to all the multinational companies without differentiating between highly capital intensive industry and low capital intensive industry which causes hardship with multinational companies belonging to highly capital intensive industries.

Analysis : A very famous English proverb “ Don't colour your painting with single colour” seems to be appropriate here. The intent behind to incorporate this provision is to curb the arrangements which are used as a tool for base erosion rather than disallowing the appropriate claim of interest expenses. OECD has also recognized this hardship in its BEPS action Plan 4 and accordingly, suggested an additional ratio known as “Group ratio” which provides that interest claim should not be disallowed if the debt equity ratio of taxpayer is not more than the debt equity ratio of the group as a whole.

Suggestion: Hon'ble Finance minister should introduce this Group ratio as suggested by the OCED under the Indian transfer pricing regime.

2. Alternative Dispute Mechanism- Dispute Resolution Panel

Issue: Failure to achieve the objective of providing mechanism for speedy disposal of cases so as to attain finality

Analysis: DRP was constituted with an objective as stated below “The dispute resolution mechanism presently in place is time consuming and finality in high demand cases is attained after long drawn litigation till Supreme Court. In order to address the concern of the multi- national companies and to provide mechanism for speedy disposal of their cases so as to attain finality, a new section 144C is inserted in the Income-tax Act to facilitate expeditious resolution of disputes.”

However, DRP has miserably failed to achieve its said objective owing to

a. All members are revenue persons and hence, does not have neutral approach in deciding the case.

b. Person having commercial knowledge about the working model of various industries across the globe is not on the panel which causes lack of commercial sense in appreciating the cross border arrangement.

c. Accounting plays an important role in determining the Arm's length price of the transaction and the missing of such accounting experts on the panel is also one of the causes for failure of DRP in achieving its objective.

d. 9 months Timeline does not allow the panel to provide more than 2-3 hearing prior to decide the case which sometimes violate the principle of natural justice.

Suggestion

1. Panel should comprise 

a. Eminent Person from Indian legal service having expert knowledge and experience in dealing with cross border arrangements and transactions.

b. Eminent Person from industries having commercial knowledge and experience.

c. Eminent Person having expert knowledge in accounting field, tax field and other economics laws.

2. Timeline should be enhanced to at least a year from 9 months.

3. Advance Pricing Agreement

Issue: APA is one of the finest programme introduced by the Govt to bring certainty in relation to transfer pricing adjustment, for the Multinational groups. However, the process of the same needs to be further simplified.

Analysis: Section 92CC mandates to take the Central Govt. approval for concluding the APA, the necessity of which is difficult to understand as there is no provision under the Income tax Act, 1961 which requires the interference of central government in assessment stage, appellate stage, even at any stage of litigation. Thus, Central Govt approval in the process of alternate dispute mechanism not only causes delay in the conclusion of APA but also discourages the business community in adopting the same.

Suggestion: The requirement of central Govt approval should be discontinued.

4. Secondary Adjustment

Issue: Whether the Income tax Act can mandate the taxpayer and its AE to make an adjustment in its books of accounts?

Analysis: It seems that Income tax Act does not have jurisdiction to ask the foreign companies to make any adjustment in their books of accounts either in cases where their income is not liable to income tax in India or otherwise.

Suggestion :

1. Books of accounts should be clarified as what is required to maintain u/s 44AA of Income tax Act, 1961.

2. The definition of Secondary adjustment should be redrafted.

5. Interplay of Transfer Pricing and Custom provision

Issue: Presently, both the SVB officer and transfer pricing officer determine the separate transaction value of the transactions as per their wish despite having common objective of collecting taxes/ duty what it would collect if both the parties were not related one.

Analysis: The common objective of both the officers is to collect taxes/ duty what it would collect if both the parties were not related one. However, both determine the separate transaction value for the same transaction as per their selected comparable, etc despite having almost similar methodology to calculate the transaction price of the imported /exported goods. The Law only allows the authorities to collect the tax/duty on the transaction price, which unrelated parties would enter into if they are the parties of the transaction rather than allow the authority to determine the tax/duty amount on the transaction value as per their wish. The determination of transaction price done twice not only wastes the time of taxpayers as well as tax authorities but also causes higher payment of duty and taxes by the taxpayer as compared to unrelated taxpayer which is against the spirit of Law.

Suggestion: All the transaction value of import and export of goods determined by the SVB should be deemed to be the Arm length price under the Indian Transfer pricing regulation. 

External Commercial Borrowings (ECB) are commercial loans raised by eligible resident entities from recognised non-resident entities and should conform to parameters such as minimum maturity, permitted and non-permitted end uses, maximum all-in-cost ceiling.

Information for the editor for reference purposes only

The article includes inputs from Sanket Khuthia, Deputy Manager, Deloitte India.

• BEPS Action 4 suggests that the limitations on interest deduction should not apply to companies engaged in carrying out quasi-banking or other financial activities in a regulated framework;

• The business of NBFC is akin to that of banks i.e. interest constitutes the major income stream as well as substantial operating cost for NBFCs and thus a cap on the deductibility of interest expense could be onerous to the growth of the sector;

• Similar to banking industry, NBFCs are regulated by the Reserve Bank of India (RBI) and are required to follow stringent capital requirement norms prescribed by the RBI. There are enough checks and balances, therefore, to regulate the activities of NBFCs and the interest expense incurred within the framework.

• Step 1: Computing the group's overall third-party interest as a proportion of the group's earnings before interest, taxes, depreciation and amortisation (EBITDA).

• Step 2: Ratio derived in Step 1 to be used for individual company's EBITDA to determine the limit for allowable interest.