Dialogue on Reforms for Smoother Corporate Restructuring

This article has been co-authored by Dipesh Jain (Director) and Smeet Jain (Deputy Manager), Deloitte Haskins and Sells LLP

The COVID-19 pandemic has wreaked havoc across the world, affecting major businesses globally. Business leaders across the globe, by and large, are struggling to predict and accurately assess the impact of the pandemic on their businesses, including on market situations as well as on people.

Mergers & Acquisitions (M&A) activities were also gravely impacted during the initial period of COVID-19 and are now slowly moving towards the recovery phase to some extent. It is expected that as businesses tread beyond recovery, M&A activity will likely thrive too.

It is pertinent to note that all eyes are on Budget 2021 now; especially given that the government is keen on providing boost to the economy which should logically include M&A activities and securities market as well; a US$ 5 trillion economy would surely require this level of support from the government.

Some key expectations from an M&A and corporate restructuring standpoint are as follows:

1.           Carry Forward of Losses

1.1         Carry forward of loss in the case of amalgamation of companies NOT owning ‘industrial undertaking’

• As per the provisions of the Income-tax Act, 1961 (ITA), losses attributable to the Demerged Undertaking are available in the hands of the Resulting Company. Going by the same intent and logically speaking, losses of amalgamating companies should be available in the hands of the amalgamated companies – mergers and demergers should be on similar footing and there is no reason to have a disadvantageous tax treatment for mergers as compared to demergers.
• Accordingly, accumulated losses should be available in the hands of the amalgamated companies without the need to single out only the entities which satisfy the condition of owning an “industrial undertaking”.
• This would, inter-alia, encourage consolidation, growth and make India a competitive country for foreign investments. This would also, in a way, ensure creating / sustaining employment opportunities; especially in cases where the amalgamating companies would otherwise not have been able to carry on the business, if it were not to be for consolidation with other entity(ies).  At the least, section 72A of the ITA should be widened to include – e.g. - real estate / infrastructure / capital intensive service sectors such as tower companies,  Direct to Home operators, entertainment industry, etc. within its fold.

1.2         Carry forward of losses in case of change in shareholding

• Change in shareholding typically takes place on account of capital infusion in the company by a new investor or change in management where the existing promoters dilute in favor of new set of promoters to run the company.
• In either case (i.e. primary infusion of funds or secondary exit), the critical considerations are primarily one of the following – (i) revival of the existing company (ii) expanding the outreach of the operations (iii) sustaining competition in the marketplace (iv) technological advancement; or (v) providing superior quality output / curtailing costs to provide cheaper products.
• It is to be noted that any primary / secondary transaction in the capital market ultimately leads to economic advancement for the country as a whole in some way or the other – be it (i) employment generation, or (ii) favorable cross-border trade, or (iii) better goods and services to the population at large in terms of better quality products or cheaper products, or (iv) higher taxes in terms of increased economic activity, and the like.
• In light of the benefits which could be achieved in terms of this kind of M&A activities, especially in the difficult sectors / companies which are into persistent losses or with long gestation periods,  it would be prudent not to expose the losses in such companies, just on account of change in shareholding.
• Deletion of Section 79 of the ITA would definitely attract a lot of M&A activity in the troubled companies, which in turn would strengthen the economic activity in the country.

2.           NCLT Approved Schemes of Arrangement

2.1         Applicability of section 56(2)(viib) in case of issue of shares upon merger/ demerger

• Due to court-approved amalgamations or demergers, non-cash transactions get tax neutrality benefits on meeting prescribed conditions. However, while issuing shares pursuant to such amalgamations or demergers, there is no specific exemption on the applicability of the super-premium rule under the section 56(2)(viib) of the ITA, which can potentially distort the intended overall tax neutrality concept for such schemes of arrangements.
• There is a specific carve out for NCLT approved schemes complying with merger / demerger conditions from the wrath of section 56(2)(x) of the ITA as well.
• In light of the above, appropriate clarification is required to exclude non-cash transactions arising out of a merger or demerger, which is otherwise tax neutral, from the purview of the section 56(2)(viib) of the ITA.

2.2         Cross-border M&A transactions

• Tax neutrality benefits, which are otherwise available in case of a merger / demerger of any Indian company into another Indian company i.e. domestic transactions, have not been extended to transactions arising on account of similar outbound cross-border transactions.
• This has been one of the disincentives for Indian promoters considering cross-border deals (in spite of a smooth regulatory process carved out for such cross-border arrangements). A specific tax exemption ought to be provided for such transactions to enable flawless cross-border mergers and demergers to enable Indian companies to be competitive and stand out in the global arena

3.           LLP Structure

3.1         Merger / Demerger of Limited Liability Partnership

• While Limited Liability Partnerships (LLP) have been recently promoted as a form of organisation – with liberalisation in the FDI regulations as well – certain tax and regulatory relaxations are still required to bring it on par with the corporate structure, especially as regards consolidations and carve-outs.
• LLP vehicles, which have been popular among small and medium enterprises and service-oriented businesses, could flourish well in case re-organisations (such as merger / demerger with other LLP/companies) are expressly permitted under the regulations. There is a need to extend tax protection and benefits as well (such as enabling carry forward of tax losses and providing tax neutrality) to LLPs and their partners undergoing re-organisations. This is more so required now as during the pandemic, many such small and medium enterprises have had to endure a lot;  the flexibility to join hands with similarly placed entities will help them to face the challenges thrown by the pandemic and ensure continuity of operations.
• It is recommended that benefits of section 72A of the ITA be extended to merger and demerger undertaken between LLPs. This will facilitate the ease of doing business and create a desirable business atmosphere for companies and LLPs and bring the tax treatment for such transactions at par with that available to Indian companies on similar transactions.

3.2         Conversion of LLP into Company

• Shareholders are protected as regards conversion of “company into LLP”, however no specific exemption is provided to partners of an LLP in case of conversion of “LLP into company”.
• It is recommended that section 47(xiii) of the ITA be brought in line with provisions of section 47(xiiib) of the ITA, by providing specific exemption to partners pursuant to conversion of LLP into a corporate structure.

4.           Other Asks

4.1         Relaxation from gift taxation provisions pertaining to acquisition of stressed assets undergoing insolvency process

• Pursuant to the pandemic, there is apprehension of a rise in the number of corporates likely to face Insolvency and Bankruptcy Code (IBC) proceedings. Under the current law, acquirers of shares in companies pursuant to such IBC proceedings are subject to tax on account of potential valuation adjustments. To address this issue, the scope of transactions, being currently excluded from the purview of section 56(2)(x) of the ITA, ought to be extended to cover transactions that are undertaken in line with a resolution plan approved by the National Company Law Tribunal (NCLT).
• Similar relaxation for IBC related cases should also be provided under section 50CA and 56(2)(viib) of the ITA which are more of anti-abuse provisions.

4.2         Rationalisation of Tax Collection at Source (TCS) applicability in certain cases

• TCS exemption availability only to listed shares have created a stir in the M&A market.
• Shares and securities which are part of any M&A transaction are subject to TCS even if the buyer is not carrying on any business in India. There is an urgent need to address this aspect, else while TCS is collected, the same would have to be refunded with interest by the Government.
• In light of this, suitable amendments should be brought about to keep transactions in securities outside the ambit of section 206C(1H) of the ITA.

4.3         Exemption from capital gains on indirect transfers within the group as part of re-organization

• It is recommended that specific provisions be introduced for exempting intra-group transfers as part of group re-organizations from the indirect transfer provisions.

4.4         Taxability of deferred considerations

• Taxability on gains arising on account of deferred consideration is a matter of protracted litigation.
• It should be clarified that deferred consideration, especially consideration, which is contingent in nature, will only be taxed in the year of receipt of such consideration in the hands of the seller.

Concluding remarks:

The government has been highly proactive during the pandemic and has tried to resolve the bottlenecks in various areas all this while.  It has also been agile in various other areas on the tax front in the recent past – to name a few – Vivad se Vishwas, faceless assessments, e-invoicing under the GST regime, etc. Various timely measures have been taken by the government during last three quarters (of the pandemic) –promoting public expenditure, keeping IBC in abeyance, extending the due dates for various filings, providing moratorium periods for borrowings, reducing withholding tax rates – just to name a few.

It will be extremely helpful and opportune if the government now provides certain relaxations as discussed above, which would offer the much-needed impetus to the struggling economy to enable businesses to find their feet through restructuring / combinations with other similarly placed entities.

A traction on the mergers and acquisitions front would definitely push economic activity, including provide positive vibes amongst the offshore investors looking at India as an investment destination. Hopefully the trend of the government’s bold strides in the recent past would continue and we would get to see the same in the much-awaited Union Budget 2021.

Provision for bad and doubtful debts is typically not tax deductible except in case of specified financial institutions including banks, where such provisions are allowable, subject to limits as deduction while computing taxable income [section 36(1)(viia) of the Income-tax Act, 1961 (the Act)].

Bad debts written off as irrecoverable in the accounts of the taxpayer are typically tax deductible [section 36(1)(vii) of the Act] but in case of specified financial institutions, it is allowed to the extent it exceeds the amount allowed as deduction for provision for bad and doubtful debts under section 36(1)(viia) of the Act.

Further an explanation was inserted by the Finance Act 2001 with retrospective effect from 1 April 1989, under section 36(1)(vii) to clarify that any bad debt or part thereof written off as irrecoverable in the accounts shall not include any provision for bad and doubtful debts made in the accounts.

Banks also have a concept of technical write off of bad debts where the individual loan or debts are not written off in the branch accounts but done so in the head office books of accounts. The Reserve Bank of India (RBI) requires banks to disclose technical write off separately in its financial statements vide RBI Master Circular dated 1 July 2015 on “Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances”.

The purpose of giving this background is to understand the context in which the Supreme Court passed the order in the case of Vijaya Bank vs. CIT [2010] [TS-120-SC-2010-O] (SC).

The questions that arose for determination before the SC concerned the manner in which actual write-off takes place and whether it is imperative for the assessee bank to close the individual accounts of each debtor in its books or whether a mere reduction in the "Loans and Advances Account" or Debtors to the extent of the provision for bad and doubtful debt is sufficient?

The matter related to the Assessment Years 1993-94 and 1994-95 i.e. post amendment by the Finance Act 2001.

The SC referred to the decision of the division bench of the SC in the case of Southern Technologies Ltd. v. Jt. CIT [2010] [TS-5003-SC-2010-O] wherein it was held that prior to the amendment even a provision could be treated as a write-off. However, after April 1, 1989, a distinct dichotomy has been brought in by way of the said explanation to section 36(1)(vii). So post April 1, 1989, a mere provision for bad debt would not be entitled to deduction under section 36(1)(vii). To understand the above dichotomy, one must understand 'how to write off'. If an assessee debits an amount of doubtful debt to the profit and loss account and credits the asset account like sundry debtor's account, it would constitute a write-off of an actual debt. However, if an assessee debits 'provision for doubtful debt' to the profit and loss account and makes a corresponding credit to the 'current liabilities and provisions' on the liabilities side of the balance-sheet, then it would constitute a provision for doubtful debt. In the latter case, the assessee would not be entitled to deduction after April 1, 1989."

The SC further noted that the assessee-bank has not only been debiting the profit and loss account to the extent of the impugned bad debt, it was simultaneously reducing the amount of loans and advances or the debtors at the year-end. In other words, the amount of loans and advances or the debtors at the year-end in the balance-sheet is shown as net of the provisions for impugned debt.

Thus the SC held that it was not imperative to close individual account of debtors to claim bad debts write-off.

Banks typically disclose under the asset side of the Balance Sheet in the annual accounts, the Loans and Advance and / or Debtors, net of Provision for bad and doubtful debts. 

So would this mean that all provision for bad and doubtful debts are allowable as bad debts written off just because in the annual accounts the same is shown as net off against the Loans and Advance / Debtors?

The decision of the Supreme Court refers to the concept of head office account and rural branch account, and also refers to the fact that the head office account clearly indicates write-off of the loans and advances. It further mentions that the loans and advances or debtors at year-end is reduced against the provision for impugned debt. Would this imply that the SC was examining the concept of technical write-off of bad debt and not the general provision for doubt debts?

On reading the decision, it appears that the Supreme Court has held provision for impugned debt which is more akin to the technical write-off deductible as bad debt written off but not the general provision for doubtful debts. The decision of the SC in Vijaya Bank could be interpreted differently and so suitable amendment be made to the Act or a clarification be issued to avoid tax litigation.

Information for the editor for reference purposes only

Time to Dot the I's and Cross the T's

ESOPs Taxation: Start-ups are integral to our dream of a large and diversified economy. One of the biggest challenges faced by startups is hiring and retaining good talent. ESOPs bridge this gap by acting as an effective tool for this purpose. They also have the added advantage of creating a sense of ownership by employees within the start-up. ESOPs should be taxed in the hands of employees at the time of the actual sale or transfer, period. Current provision of timelines for presumed monetization of capital tables within 5 years or continuation of employment within a said start-up as conditions should be done away with for the purposes of deferment.

Furthermore, it will be ideal to recognize Stock Appreciation Rights (SARs) or Unit award agreements with underlying value linked to enterprise valuation or equity as equivalent to ESOP for the purposes of taxation, given the steadily increasing adoption rates by start-ups as preferred choices for incentives.

FEMA: All FX inflows and outflows continue to remain subjected to substantial reporting, limits procedures set by the RBI, which increases latency for closing transactions on both inward investments as well as outward returns either by way of original capital, interest, or dividends.  There is an urgent need to eliminate procedures which do not add any reasonable value in terms of oversight, especially on capital transactions under the automatic route. Further, all efforts should be made to reduce compliance procedures associated with all FX transactions, as these end up becoming barriers to transactions. 

Transfer Pricing: India continues to remain a preferred target for setting up captive centers. There is a general lack of clarity, especially amongst small and medium enterprises on the transfer pricing norms. The government should create the concept of “MSME Captive centers” (potentially with revenue cutoffs) and giving captive centers the optionality to price their contracts at margins mentioned under the tax code. Alternatively, the same can be achieved by way of generic APAs for standard service lines. Once applied, the tax code should assume that the pricing is on Arm’s length basis and de-risk the captive centers from further scrutiny under the TP norms.

Payroll: Socialist-era regulations related to employee payroll (for example Bonus, Gratuity) should be eliminated. Employers effectively consider all regulations under the CTC concept thereby resulting in the regulation adding compliance costs for employers and deferment of salary in the hand of employees. Further, the labor ministry should assess inviting tech platforms to build API for social service platforms like EPF/PPF/NPS/ESIC which can be then used by third party payroll processing systems to allow for direct deposit & filings or returns with the agencies. This will likely pave the way for creation of tech-based payroll systems & reduce compliance costs for businesses.

GST: Since its implementation in 2017, the GST Act and its associated procedures have become more complex with every passing year. It will not be untrue to say that the current system has overtaken the previous one in terms of complexity and added additional compliance costs for businesses.

Taxation Shot for Pharma Industry

This article has been co-authored by Salika Kothari (Manager), Rajeshree Sabnavis & Associates.

‘India’s pharma industry is an asset for entire world’, says PM Narendra Modi. The pharma industry has played a vital role in recent times while responding to the unprecedented COVID-19 crisis. This Article attempts to bring out the Direct Tax proposals that the pharma companies are looking forward to getting the much needed shot in the arm from the upcoming Budget 2021.

1. Reintroducing weighted deduction for Research and Development (R&D) expenditures

Supporting the world’s battle against COVID-19, many pharma companies have engaged themselves in active research pumping in huge funds and taking on themselves massive risks. Section 35(2AB) of the Income-tax Act,1961 (the Act) had provisions relating to enhanced deduction for undertaking / making contribution for scientific research. Such R&D expenditure payments were earlier eligible for weighted deduction (ie more than 100%) in certain scenarios, which has been reduced to 100% from Budget 2020. As a one-time measure, the Government may consider restoring the weighted deduction in Union Budget 2021 to encourage pharma companies making contribution to R&D expenditures, which in turn will enable new discovery and innovation.

Further, at present, the R&D expenditure are being regulated by DSIR, which approves R&D expenditure as per its own standards. To reduce any ambiguity around the claim of R&D expenditure for tax purposes, it is recommended that Budget 2021 should restrict DSIR role to merely approving of R&D facility and expenditure claims from a tax point of view should be examined by the Income Tax authorities only.

2. Improvising New tax regime

Budget 2020 had inserted two Sections namely Section 115BAA and 115BAB to grant benefit of a reduced tax rate to domestic companies. While the existing domestic companies have been provided an option to pay tax at a concessional rate of 22% (excluding surcharge and cess), new domestic companies set up on or after October 1, 2019, and commencing manufacturing before March 31, 2023, would have the option to pay tax at 15% (excluding surcharge and cess). The option to avail the reduced rate of tax is subject to fulfilment of certain conditions prescribed therein which, inter-alia, includes companies will not be able to take deduction of R&D expenditures incurred by them and donations made by them.  Budget 2021 should allow deduction for R&D expenditures incurred by pharma companies and towards Covid-19 related donations made by pharma companies while calculating total income under the new tax regime. Also, the Government may consider expanding the regime to benefit not only entities engaged in the manufacturing space but also providing services to encourage players across the value chain and to create a conducive growth environment for the sector as a whole.

3. Deductibility for COVID related expenses incurred by pharma companies

In the current scenario, many pharma companies have expended on additional safety measures, community welfare expenses or increased Corporate Social Responsibility (CSR) expenditure. Currently, Section 37(1) of the Act, disallows any expenditure incurred towards the CSR/ expenditure incurred not wholly and exclusively for the purpose of business or profession. Considering the impact that the pandemic has had on the business community at large and the need to continue with sustained efforts in this area, supporting the industry by way of a reduced tax impact on such expenditure is a much needed ask of the day, Accordingly, Budget 2021 should clarify that all expenses related to COVID-19, whether part of CSR or otherwise would be fully allowed as deduction under Section 37(1) of the Act.

4. Widening scope of Patent Box Regime

The benefit of Section 115BBF of the Act, is restricted to ‘true and first inventor of the invention’ of patent developed and registered in India. It is recommended that Budget 2021 should be makeshift to allow application of the reduced tax rate even to assignees / transferees of the patent to encourage larger players like corporates and LLPs to invest in this space and not restrict such benefit to only the true and first inventor of the invention.

Further, with India’s desire to be recognized as a leading player in the global pharma space, restricting benefits to work done or patent registrations procured in India could prove to be counter-productive. Accordingly, to truly incentivize players in the Indian pharma space to go global, Budget 2021 should expand the benefits of Section 115BBF to patents developed and registered in foreign country also.

5. Clarification on MCI Circular

As per Circular no 5/2012 dated August 1, 2012, issued by the CBDT, expenses incurred for providing freebies (gift, travel facility, hospitality, cash, or monetary grant) to doctors are inadmissible under Section 37(1) of the Act, as it violates MCI Regulations, 2002. MCI Regulations, bar doctors from accepting any gift, travel facility or cash grant from any pharma or allied healthcare industry in return for the referring, recommending, or procuring of any patient for medical, surgical, or other treatment. The taxpayers have been contending that the MCI Regulations do not apply to pharma companies and healthcare industry as they are code of conduct for healthcare professionals whereas, the tax department has been citing the same to disallow expenditure under Section 37(1) of the Act. This issue is highly litigative. The Government should issue a clarificatory circular that MCI Regulations are binding on health care professionals and not binding on pharma companies. Further, Government should constitute panel to define expenses that could be deductible by pharma companies under Section 37(1) of the Act to ensure a wide-spread investment being made by pharma companies to ensure that healthcare benefits are not restricted to a select community.

6. Extension in reduction of Tax deducted at Source (TDS) rates

In order to increase liquidity in the hands of an individual who is already battling the financial distress due to COVID-19 pandemic, the Government vide Press release dated May 13, 2020, has reduced TDS and tax collection rates (TCS) rates by 25% for payment or credit made till March 31, 2021. With the effect of the pandemic still being felt across sectors, it is suggested that reduction in TDS rates on payment to residents may be further extended upto March 31, 2022.

7. Abolishing TCS on sale of goods to reduce administrative compliances

The Government has levied TCS by inserting a new Section 206C(1H) of the Act, on sale of goods. As per the provision of Section 206C(1H) of the Act, tax is required to be collected at the rate of 0.1% (0.075% till March 31, 2021) by the seller, on sale of goods, if the sales consideration exceeds Rs. 50 lakhs from a buyer during the previous year. There are challenges being faced by taxpayers such as treatment of sales return and post-sale discounts in collection of TCS.  Further, TCS provisions are very complex and time-consuming requiring updating the accounting and finance processes, collecting TCS from buyer, depositing with the Government and filing quarterly TCS returns. Considering that the Government is already entitled to collect taxes by way of advance tax from the income recipients, subjecting the industry to more time consuming and cost inefficient tax compliances, by way of TCS provisions, is a counter-productive measure. Hence, it is recommended that Budget 2021 should do away with the provisions relating to TCS on sale of goods.

8. Guidelines on relaxation in domestic tax law to exclude number of days spent by employees of foreign companies in India

The tax residency status, in India, of an individual is dependent on the number of days that he or she stays in India and not on citizenship. Cross border movement of employees is severely impacted due to COVID-19 outbreak which has resulted in creation of permanent establishment exposure of foreign companies in India on accounts of stay of their employees in India. Budget 2021 should clearly issue guidelines on relaxation in domestic tax law to exclude number of days spent by employees of foreign companies in India due to exceptional circumstances beyond their control. While drafting the guidelines, the Finance minister could take aid from OECD Guidance released earlier this year, addressing the tax implications of employment changes arising due to COVID-19 pandemic involving cross-border workers. It has been recommended by OECD that the exceptional and temporary change of the location where employees exercise their employment because of COVID-19 crisis, such as working from home should not create new permanent establishment for the employer.

Concluding remarks:

The Government has been highly active during the pandemic and have tried to resolve issues in many areas in the recent past to name a few are introducing by Vivad Se Vishwas, extending due dates for various filings, reducing TDS rates. Given the impact of the pandemic, witnessed by the country and the world at large, a ‘Healthy Pharma Industry’ is the need of the hour. In addition to the steps already taken by the Government, the above measures will go a long way in fortifying the position of the Pharma companies both in India and globally.

Taxability of Interest Ex-gratia – Need for Clarity

The Government of India has provided significant relief to the public in general in view of the COVID-19 pandemic that has affected the Indian economy and people. Some of the relief measures could have income-tax implications and may necessitate amendments in law / clarifications.

In view of the extreme COVID 19 situation, the Government of India, has approved the scheme for grant of ex-gratia payment of difference between compound interest and simple interest for six months to borrowers for specific loan accounts[1].

The object of the scheme was to provide relief for the period from 1 March 2020 to 31 August 2020, to eligible borrowers, through lending institutions. Such payment does not constitute a contractual, legal or equitable liability of the central government and is only an ex-gratia payment to the designated class of borrowers in view of the COVID-19 pandemic. All banking companies registered with RBI have been advised to ensure that the ex-gratia amount payable under the scheme should be credited to the account of the eligible borrowers, on or before November 5, 2020. Post this, banks can lodge their claim for reimbursement latest by December 15, 2020 with the central government through the State Bank of India (SBI). Borrowers in certain segments/classes of loans (e.g. MSME, education, housing, consumer durable, credit card dues, automobile, consumption and personal loan to professionals), who have loan accounts having sanctioned limits and outstanding amount of not exceeding Rs.2 crore (aggregate of all facilities with lending institutions) as on 29 February 2020, were eligible under the scheme.

Any borrower whose aggregate of all facilities with lending institutions was more than Rs.2 crore (sanctioned limits or outstanding amount) was not be eligible for ex-gratia payment under the scheme. The account should not be a Non-Performing Asset (NPA) as on 29 February 2020. Further the ex-gratia payment should be admissible irrespective of whether the eligible borrower had fully or partially availed or not availed of the moratorium on repayment announced by the RBI.

A question arises whether the said ex-gratia payments should be taxable income for the borrower.

The term ‘ex-gratia’ has not been defined under the Income-tax Act, 1961 (the ITA or the Act) and so reference may be made to the general meaning of this term. Ex-gratia is generally understood as given as a favour or from a sense of moral obligation rather than because of any legal requirement (Oxford language).

Income has been defined under the Act to inter alia include “assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government” [Section 2(24)(xviii) of the ITA]. The said clause was inserted by the Finance Act, 2015 w.e.f. 1 April 2016.

Circular no. 19/2015 explaining the provisions of the Finance Act 2015 provides the intention of introducing the above clause so as to align the Act with the Income Computation and Disclosure Standards (ICDS). It also clarifies that “5.2 As mentioned in Press Release dated 5th May, 2015, the amended definition of income shall not apply to the LPG subsidy or any other welfare subsidy received by an individual in his personal capacity and not in connection with the business or profession carried on by him.”.

ICDS VII deals with government grants and is applicable only in case of income computed under the head, ‘Profits and gains from business or profession’ and ‘Income from other sources’ in case of all taxpayers, except for individuals and HUF, who are not required to get their accounts audited under the Act.

Section 10 of the Act which deals with income not chargeable to tax, earlier provided for income which was of casual non-recurring nature of less than Rs 5000, as exempt from tax, subject to such income not arising from business or profession or services. This exemption has since been deleted.

Section 56 of the Act, inter alia provides that where any person receives, in any previous year, from any person or persons, any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum should be taxable as income from other sources.

The Supreme Court in the case of Padmaraje R. Kadambande v. CIT [1992] [TS-5024-SC-1992-O] (SC) has held that “Section 2(24) defines in an inclusive manner what 'income' is. The word 'income' connotes periodical monetary return coming in with some regularity or expected regularity from definite sources. In the facts of this case, the assessee continued to receive cash allowance as compassionate payment from the government post discontinuation of monthly cash allowance after the merger of Kolhapur State in the then state of Bombay. The SC held that there was no compulsion on the part of the government to make the payment since it was purely discretionary. The payment made by the government was undoubtedly voluntary. However, it had no origin in what might be called the real source of income. Further, it was compassionate payment, for such length of period as the government may, in its discretion, order. In view of the above, the amount received by the assessee, was held as a capital receipt and, therefore, was not income within the meaning of section 2(24).”

The ex-gratia scheme is applicable only to certain eligible borrowers that meet the specified conditions as per the scheme. Such payment does not constitute a contractual, legal or equitable liability of the Central Government. Also, the intention of the grant is to provide financial support to individuals. In such a scenario, a question arises as to whether the ex-gratia should be treated as income in the hands of the borrowers and if so, whether the financial institutions would be required to withhold tax on such waiver of interest. If so, it shall result in additional tax burden on the borrowers who would already be struggling with the economic crisis due to the pandemic. 

Since the issue is subject to interpretation, a clarification to this effect or insertion of an additional provision in the Act on the taxability of such ex gratia payment would be helpful keeping in mind simplification and certainty in tax laws.

Information for the editor for reference purposes only

Alifya Hakim is Director and Lovina Mathias Daniel is Manager with Deloitte Haskins & Sells LLP

Budget Expectations 2021 – Corporate Restructuring

This article has been co-authored by Damini Dhull (Senior Associate), Nangia & Co LLP .

Budget Expectations 2021 – Corporate Restructurings

As the world copes with the uncertainty of the Covid-19 pandemic, India Inc. too, has been working overtime, formulating its response to the crisis.  With the wheels of economic growth grinding to a halt, the pandemic has mutated into an economic crisis.   The high impacted sectors in terms of risk on account of Covid-19 are aviation, hotels, restaurants, shipping, ports and port services. The medium impact sectors are automobiles, building material, residential real estate while low impact sectors include education, dairy products, FMCG and healthcare. COVID-19 has impacted varied industries alike resultantly restricting the feasibility of mergers and acquisitions including inbound foreign investments in India. The global and domestic economic disruption has caused delay (in several cases indefinitely) in completing may trade transactions. The global supply chain fallout and restricted international borders have forced investors to take a relook at the valuation of the assets underlying the ongoing and future deals. This unprecedented environment has also triggered a need for a deeper due diligence exercise to assess closely and identify the underlying vulnerabilities to COVID-19 and its economic impact.

With this as a backdrop, there are high expectations from the finance minister to present a growth oriented budget which can help boost economic activity which is wheeling under the effects of COVID-19 pandemic. Some of our key expectations from Budget 2021 are as under:

• Extending Section 72A benefits to Service Sector Companies

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 55.39% of India's Gross Value Added in FY2020. Accordingly, the lawmakers should recognize the importance of promoting growth in services sectors and providing incentives therein. Considering the same, the ministry should Extend benefits of carry forward of losses under section 72A of the Act to all sector companies especially to service sector companies. The necessary amendments should be made in Section 72(A)(2) and Section 72A(2)(b) as well.

• Tax Neutrality for Outbound Mergers

Presently company law and FEMA permits merger of Indian companies with global corporates. However, the Income Tax act does not provide for tax neutrality with respect to such outbound mergers. It is recommended that appropriate amendments are made in the Income Tax law to provide for tax neutrality in relation to such outbound mergers. This would act as a big incentive for Indian promoters considering cross-border acquisitions / mergers and the economy would witness more and more of global M&A which is the need of the hour.

• Deferred/Contingent Considerations

The increase in risk premium owing to the novel Covid-19 has re-opened negotiations of term sheets and in several cases transaction documents. Investors are now preferring tools like deferred consideration and earn-outs which permit a ‘wait and assess before you fully invest’ approach, which is gaining more popularity in M&A structuring. Therefore, it’s important that the tax laws provide for necessary clarity in respect of  taxation of such deferred or contingent consideration, and ensure that there is no taxation upfront on such deferred considerations.

• Rationalization of  Section 56(2)(viib) provisions

The provisions of Section 56(2)(viib) were introduced for taxing excessive share premiums by a closely held company upon the issue of shares. The intent of the legislature in enacting the provisions of this section was to discourage the practice adopted by tax payers of subscription to shares of closely held companies at excessive and unjustifiable premium, however this taxation has thwarted angel investment activities as well as HNI investment in private companies who are in need of private investor funds for expansion. In view of the same, its recommended that provisions of Section  56(2)(viib) be rationalized such that its application is only in cases of intended situations of potential money laundering.

• Insolvency and Bankruptcy Code (IBC)

While the Insolvency and Bankruptcy Code (IBC) has been lauded as a commendable move by the government for providing resolution mechanism for sick companies, the tax cost still acts an impediment. Though the Minimum Alternate Tax (‘MAT’) provisions have been amended to provide deduction of losses including depreciation to such companies, book profits arising from waiver of debt as a result of haircut taken by lenders result in high MAT cost—a major bottleneck in the resolution process. Such haircuts should be specifically exempted from the levy of MAT. Also, acquisition of shares of a company undergoing insolvency resolution process under IBC should also be exempted from taxation under the deeming fiction of section 56 of the Income-Tax Act. Further, considering that the main objective of a resolution plan under the IBC is to maximise the value of assets of the company undergoing insolvency resolution process and thereby for all creditors, in any case, a specific carve-out should be provided under General Anti-Avoidance Rules (GAAR) for any transaction undertaken as a part of the resolution plan.

• Conversion of Partnership Firm/LLP into Company

When an Indian partnership firm or LLP gets converted into a company or vice-versa there are many conditions attached to make it tax neutral one such condition is the continuity of shareholding. It is recommended that such post conversion conditions (of continuation of shareholding etc) ought to be relaxed, so that smaller organizations will have more opportunities for fund raising as well as growth.

• Other Suggestions for enabling corporate restructuring include-

• Ensuring uniformity in stamp duty across India for Scheme of Arrangements approved by the National Company Law tribunal.
• Provide clarity to settle the ambiguity under carry forward and setoff of losses under intra group reorganizations where the ultimate (beneficial owner) remains the same.
• Providing shareholder level exemption in case of indirect transfer of shares of Indian company in cases of merger or demerger of foreign companies
• Providing clarification or express exemption for schemes sanctioned by NCLT from GAAR provisions to reduce widespread litigations.
• Benefit of clause (iv) and (v) of Section 47 to 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.
• Clarification on tax neutrality in case of demergers, where the demerged assets and liabilities are recorded at fair value in line with accounting mandate under Indian Accounting Standards (IndAS).
• Specific provision enabling revision of tax returns to give effect to the scheme of arrangement even after the due date of filing revised returns, especially considering the amended curtailed timelines for revision of return.

Post Covid-19 pandemic, the economy has certainly moved from abject hopelessness to a level of renewed confidence that India would get back on track to be among the fastest growing economies by financial year 2021-22 (FY22)-end. In the backdrop of the same, the government should deliver an impetus-oriented budget which would act as the starting point for picking up the pieces after the economic disruption post COVID carnage. The budget should ensure that the positive sentiment translates into economic momentum, supporting India’s journey to becoming a US$ 5 trillion economy by 2025. Corporate restructuring has always played an important role in a growing economy. Therefore, the government must take some positive, if not bold, measures while formulating the fiscal and tax policies for 2021 to incentivise mergers and acquisitions (M&A) deals and make the reorganisation of businesses less taxing.

Union Budget 2021 - A Case for Some Much-Awaited Tax Incentives!

This article has been co-authored by Thangadurai V. P. (Principal Associate) and Reema Arya (Consultant), Cyril Amarchand Mangaldas.

Expectations on Union Budget 2021: A case for some much awaited tax incentives! 

The year 2020 has been an unusual year for the world in more than a century. The economies across the world have been marred on account of COVID-19 pandemic and the economic slump being experienced worldwide at present has been unprecedented in every way. India is no exception.

Due to an unprecedented 23.9%[1] drop in the GDP growth in the first quarter and the resultant shortfall in the tax collections, there is an unimaginable pressure on the Government to incentivise the industries so that the economy could be revised at the earliest. However, the Government is simultaneously experiencing a huge shortfall due to falling tax collections that has curtailed the room for maneuvering in a big way. While the tax collections have suffered a serious deficit, the Government is hoping to make some windfall through the amnesty scheme - Vivad se Vishwas Act, 2020.

The union budget for 2021 to be presented by Ms. Sitharaman is just a few days away and all eyes are on the tax and other finance proposals to be included in the Finance Bill. While the business world looks up to the forthcoming budget to rejuvenate the economy, the Government will have its task cut-out to balance the serious depletion of tax collections vis-à-vis the never-ending industry expectations. There is unanimity amongst most leading economists that getting India back to the growth path is more important than worrying about tax collection shortfalls.

In this article, we have tried to identify certain aspects that the FM may bring out in the Budget 2021:

(A) Provisions to ease the stress created by COVID-19 pandemic:

In order to kick-start the recovery phase to bring the economy out of the COVID-19 pandemic induced problems, it is important that certain tax provisions are eased out to support the pandemic stressed taxpayers:

1. Incentives for generating employment opportunities: Unemployment has been a very big issue which worsened during the pandemic and it is imperative that the Government comes up with certain incentives that generate new employment avenues and provide sustainable job growth. The ambit of deduction under section 80JJAA of the IT Act can be liberalised by increasing the existing salary limit and reducing the number of days requirement. The focus could be on the knowledge economies and industries that encourages intellectual ability of the people.
2. Allowing higher depreciation: The pandemic stressed sectors may be provided a higher or additional depreciation under section 32 of the IT Act for certain years, in order to motivate capital investment.
3. Specific incentives to certain targeted sectors: There has been no major announcement of launch of a major greenfield project by any big industrialist in the recent past. It appears that the industry is adopting a “wait and watch” policy and waiting for the Government to dole out schemes before making any big announcements. There is a case to provide special tax incentives to industrialists/ companies undertaking major investments in identified greenfield projects as that can stimulate the entire ecosystems.
4. Increase in time period for carry forward of business losses: As the financial year 2020-21 will result in losses for most of the businesses, it may make sense for the time period available for carry forward and set off of business losses to be extended to 10 years as a one-off opportunity, so that the impact of COVID-19 does not come in the way of business cycles.
5. Impetus on MSME: The MSME had been and will continue to be a great job creator. The Government must stimulate job creation in MSME through additional tax incentives for new projects, reduction in indirect taxes like lower stamp duty and GST on capital investments, greater incentives for additional job opportunities, etc., in order to give effect to the resurrection of MSME sector.
6. Reduction in tax rates for LLPs and firms: While the tax rate for companies with turnover of INR 400 crores had been reduced to 25% last year, the firms and LLPs are still subject to tax at the rate of 30%. Thus, providing a level playing field to firms and LLPs by slashing the tax rates may be a wise decision.
7. Speedy processing of refund and ease in recovery of dues: The Government has prioritised the processing and issuance of pending refunds during the pandemic. While it is a welcome step, it may also be a good idea for the tax authorities to go slow on their assessment and recovery initiatives for some time, so as to give a chance to the industry to get over this unprecedented crisis and move back to their more familiar growth trajectory.

(B) Amendment in certain tax provisions:

We have highlighted below some other provisions which could be rectified/rationalized in this budget.

1. Restructuring the litigation process: At present, the process of resolution of tax litigation in India is a very lengthy, time consuming and costly affair. While it entails payment of interest and penalties by the taxpayer as per the various provisions, the chronically slow pace blocks even the legitimate dues of the Government for a long time.

The Government should come up with a permanent litigation mitigation scheme or a self-disclosure scheme wherein taxpayers shall be allowed to have a  mechanism wherein all pending or forthcoming tax disputes can be resolved in a timely and cost-effective manner.

2. Rationalising penalty provisions: The rates of penalty presently provided under the IT Act are very high being either 50% or 200% of the taxes payable. While the penalty provisions should surely exist in the statute and serve as a deterrent for taxpayers intentionally avoiding tax, the quantum should ideally be reduced and brought at par with international standards.
3. Tax in hands of shareholders for dividend should not be higher than the Dividend Distribution Tax (“DDT”) that it has replaced: Till recently, the form of entity (individual, company or any other form) did not impact the rate of taxation of dividends. However, the recent shift in the taxability of dividend in the hands of shareholders has caused an inequality wherein the individuals and private trusts are taxed at higher rate of tax which could be as high as 42.74% as opposed to 22% / 30% in case of companies and partnerships/ LLPs.

As the intention of this amendment was to make investment in equity more attractive, the rate of tax on all shareholders in respect of dividends should be capped at 20% plus surcharge and cess. No additional revenue would be lost in this scenario.

4. Dividends in the hands of unit holders of Business Trusts should be exempt: The abolition of DDT by the Finance Act 2020 has made  investments by InvITs and REITs less attractive, since the investors would have to bear the incidence of tax on dividends as opposed under the DDT regime where there was nil DDT on SPVs when they distributed dividends. Presently, dividends received by the unit holders is not exempt if the distributing company has opted for tax at the rate of 22%. This provision should be amended to ensure that dividends received by the unit holders are exempt from tax.
5. No Minimum Alternate Tax (“MAT”) on dividend income of a foreign company: When the Indian company was required to pay DDT, dividends were exempt in the hands of shareholders during the DDT regime and  foreign companies were also not liable to pay MAT on dividend income. However, as per the existing provisions of section 115JB, dividend income of foreign companies may be considered for MAT even if its taxable rate under the IT Act/ DTAA is less than the MAT rate. Therefore, section 115JB should be amended to carve out the dividend income of foreign companies from the MAT regime if tax rate of such dividend is less than the MAT rate.
6. Tax on buy back of shares of listed companies should be reduced to 10%: The difference between the consideration paid by the company on buy-back and what it received on the subscription of the said shares is taxed as distributed income under section 115QA at the rate of 20% (plus applicable surcharge and cess).

This taxability is neither aligned with the practice of taxation of buy-back across the world, nor is fair in respect of a shareholder, who faces tax incidence on buy-back at 20% (plus surcharge and cess) though levied on the company, compared to sale of listed shares resulting in long term capital gains being taxed at the rate of 10% (plus applicable surcharge and cess) under section 112A of the IT Act. Therefore, the buy-back tax in case of shares should be reduced to 10%. Further, the tax credit should be given to the shareholder, especially those who had acquired the shares in the secondary market, if the gains realized by him is less than the gains computed by the company for the purpose of buy-back tax.

7. Exemption to rights issue/bonus issue from applicability of section 56(2)(x): Section 56(2)(x) imposes taxes on the recipient who receives a property for a value less than its fair market value. The tax authorities are increasingly invoking this section to impose taxes on bonafide rights/bonus issues. This provision was introduced as an anti-abuse provision and therefore, if the taxpayer is able to establish that there is no deliberate attempt to evade or avoid taxes and there is no malafide intention in the transaction, then section 56(2)(x) should not be made applicable. More particularly, this provision should not be attracted in cases of rights/bonus issues where there are no disproportionate allotments.
8. Shareholder level exemption in case of offshore amalgamation or demerger: The IT Act grants exemption from taxes in cases of transfer of shares of an Indian company by an amalgamating foreign company to an amalgamated foreign company subject to the satisfaction of certain conditions. Similarly, it also provides for exemption in cases of transfer of shares of an Indian company by demerged foreign company to resulting foreign company, subject to the satisfaction of certain conditions. However, no exemption is provided to transfer of the shares held by the shareholders in the demerged/ amalgamating foreign company.

As India is making rapid strides towards full capital convertibility and the extent of foreign direct investment is increasing at a significant rate, it is imperative that the tax legislation is also revised to absorb and promote the new reality. In order to ensure that the intention is appropriately reflected in law and offshore amalgamations, offshore mergers and demergers do not result in taxability of non-resident shareholders in cases of such business reorganisations and also to ensure that Indian tax laws are in sync with global tax rules and regulations, it is imperative that  exemption is granted to non-resident shareholders of offshore amalgamating / demerged companies from any capital gains tax in India.

9. Time limit for withholding tax defaults in cases of payments made to non-residents: The IT Act provides no time limit in respect of passing an order against a person who defaults in deducting or depositing tax with respect to payments made to non-residents. It may be noted that 7 year limitation period is provided  for payments made to residents on which taxes were required to be withheld. Various Courts have held that the penal action should be taken by the department within a reasonable time. However, there is no clarity on what constitutes the reasonable time, and it could be alleged that the Courts can only interpret the law as drafted and should not be providing something that is missing. This leads to uncertainty and causes significant delays and unnecessary indemnities being sought in M&A transactions, which are essential for the economy. This lack of clarity needs to be addressed and in order to remove any such past anomalies, it is suggested that the time period of 7 years should also be provided in the case of payments made to non-residents as well.

Conclusion

This is an extremely crucial time period for the Government to come up with an imaginative budget that takes into account the varied degrees of expectations that has been built up over the last few weeks. The FM has also added to the hype by suggesting that this would be a unique and a “never attempted before” budget. While it remains to be seen how the budget turns out to be and to what extent, it is able to satisfy the much awaited and varied degrees of expectations across sections of the society, this is a golden opportunity for the Government to leave the horrors of the previous year behind and embark upon a new journey.

Budget 2021 - A Tool to Retain Interest of Foreign Investors

This article has been co-authored by Bhargav Selarka (Director), EY India.

The Finance Minister’s statement that this budget shall be “unlike anything in the past 100 years” has significantly enhanced taxpayers’ curiosity and amidst renewed hope of the pandemic situation improving, expectations from Budget 2021 have also increased.

While the lockdown in Q1 of FY21 and prolonged restrictions have pushed India into a technical recession which is evident from its GDP numbers, the Indian stock markets have shown promising signs with the benchmark BSE Sensex achieving an all-time high of 50,000 on the 21st day of the 21st year of the 21st century. Also, the Q2 earnings and Q3 earnings of several Indian companies have so far shown signs that an economic recovery may soon happen.

Given the optimism, the stock markets have been trading at the highest volumes and Foreign Portfolio Investors (FPIs) have been pumping in money at record highs clearly placing their faith in India as an emerging economy.

FPIs are expecting Budget 2021 to provide a stimulus to the already bullish market. A few expectations of the FPIs from a income-tax standpoint are given below:

Withholding tax on dividend pay-outs to FPIs

The removal of Dividend Distribution Tax (DDT) by the Budget 2020 has resulted in Foreign Portfolio Investors (FPIs) having to pay tax at the rate of 20% (plus applicable surcharge and cess) [subject to relief under any applicable tax treaty entered into by India].

Dividend paying Indian companies are required to deduct tax while making dividend payments to the FPIs. On account of several reasons these companies have been deducting tax at the rate of 20% (plus applicable surcharge and cess) from dividends paid to the FPIs whereas the final tax liability of most FPIs is at tax treaty rates which are lower. This has a potential cash flow impact in the hands of the FPIs as the excess taxes deducted (in cases where the tax treaty rate is more beneficial) would need to be claimed by the FPI only at the time of filing the return of income if they have no other taxes payable on any other income/ gains.

While in certain cases the excess tax may be utilised by the FPI towards its other income-tax liability for the same financial year, the excess tax withholding does result in an increase in compliances for the FPIs. Though this is a relatively minor ask the amendment to this effect enabling tax withholding at the treaty rates will boost investor sentiment.  

Reduction in long-term capital gains tax rate

With a view to increase the inflow of long-term stable foreign monies into India, it is imperative to provide attractive tax rates in comparison with the globally competitive jurisdictions. Majority of the countries in Asia-Pacific and Europe do not levy any capital gains tax on listed portfolio investments. None of the G20 countries levy capital gains tax on portfolio investments by foreign investors. India is the only country in BRIC to do so.

While until a while ago India too did not levy long-term capital gains tax on gains from transfer of listed equities, there was a policy shift in 2018 through introducing a long-term capital gains tax. While the real expectation of the foreign investors (including domestic for that matter) is for the removal of long-term capital gains tax, at best, the Government may consider reducing the long-term capital gains tax rate from 10 percent to percent and/ or the exemption limit may be enhanced to INR 5 lakhs (as against the existing limit of INR 1 lakhs).

The above changes will surely encourage the FPIs to adopt a long-term strategy so as to ensure more stability and support during the revival phase.

Removal of disparity in holding period for debt securities

Debt funding plays an equally important role as equity in providing finance to various sectors of the economy. Financial institutions as well as Indian companies issue a myriad of debt instruments for raising monies from various global and Indian investors.

From an investment standpoint, conservative/ risk averse investors prefer to make a debt investment (as against equity). Further, the debt instrument also provides for a stable source of income on a periodic basis in the form of interest.

Currently, the holding period threshold of certain debt securities like debt-oriented mutual funds, unlisted debentures/ bonds, etc is 36 months for the assets to qualify as a long-term capital asset (as against the threshold of 12 months for equities/ units of equity oriented mutual funds, etc).

Recognizing the importance of debt funding in nation building and in an attempt at providing a level playing field to the investors, the period of holding in case of debt securities should also be reduced to 12 months (owing to the beneficial rate of tax for long-term capital gains of 10%).

From an FPI standpoint, a lot of FPIs adopt a pure ‘debt’ strategy and the above proposal is likely to further incentivise and boost investment in debt instruments.

Conclusion

The Government has always paid careful attention to foreign investors’ sentiments, particularly that of FPIs which are large investors in the Indian capital market. A lot has been done over the years to simplify the tax regime for FPIs. A stable and simple set of provisions has gone and will go a long way in keeping FPIs engaged with India as an investment destination.

Union Budget 2021 - Amendments for Timely Recovery of India Inc.

This article has been co-authored by Rahul Sateeja (Counsel), DMD Advocates.

Within a week from today, the Finance Minister will be presenting the Annual Budget in the shadow of the pandemic. The Rs. 20 trillion stimuli injected into India Inc. has not healed the wounds inflicted by the most stringent lockdown which resulted in a grinding halt of the economic engines. While last few months have shown a ray of hope as economic activities have surged, the right announcements in the Budget will be crucial as it will lay down the path for a timely recovery of India Inc.

Some of the technical changes on the Direct Tax front that assessees are looking forward to are:

1. Opportunity of personal hearing to be provided as a matter of right in the faceless assessment scheme

On the Direct Tax front, there have been significant changes at a policy level. A Direct Tax Charter has been introduced with the right intentions by the Government and the entire process of assessment of income and the first appeal before the Tax Department has been shifted to a faceless scheme. The changes of this policy will be known after it has been experienced by assessees. A basic foundational defect is the denial of an opportunity of personal hearing to the assessee as a matter of right. This right has been circumscribed and is subject to the approval of the Chief Commissioner or the Director General. Considering this restriction, a petition has been filed before the Delhi High Court (Lakshya Budhiraja vs Union of India-WP No. 8044/2020) challenging the scheme to be arbitrary, discretionary and in violation of Article 14 of the Constitution of India.

It is a settled proposition of law that principles of audi alteram partem must be extended in administrative proceedings where the decision of the authority results in civil consequences [See Dharampal Satyapal vs Deputy Commissioner of Central Excise- (2015) 8 SCC 519]. Accordingly, a suitable amendment must be made in the scheme to allow every assessee, as a matter of right, to be personally heard as usually an income tax assessment entails complex issues and calculations that may not be sufficiently explained based on written submissions alone and oral clarifications are required.

2. Income arising from a transaction subject to the expanded equalization levy has to be exempted under Section 10(50) from 1st April 2020 onwards

The contemporanea expositio through the Report of the Committee on Taxation of E-Commence, 2016 is that the expanded Equalisation Levy is not a “tax on income” and therefore, the income derived from the transaction on which the expanded scope of EL applies must be exempt. Since the expanded levy is applicable w.e.f 01.04.2020, the income on a transaction of digital sales/services or facilitation thereof which is subject to the expanded EL must also be exempted from April 2020 onwards. The extant provision of Section 10(50) applies from April 2021 onwards (a year later) which must be clarified to apply from April 2020 i.e. the date of introduction of the levy.

3. Increase the efficacy of the Authority for Advance Tax Rulings

The Hon’ble Supreme Court in the case of National Co-operative Development Corporation v CIT- Civil appeal nos. 5105 to 5107 of 2009 dated September 11, 2020 recommended that a vibrant system of Advance Rulings can go a long way in reducing tax litigation. The Hon’ble Court observed that the forum established to provide certainty and avoid litigation involving non-residents has now been plagued with problems like (i) large number of applications pending due to the low disposal rate; (ii) lack of adequate numbers of presiding officers to deal with the volume of cases; (iii) vacancies and delayed appointments of members; (iv) average time taken is 4 years in deciding an application. Due to these ground realities, the very purpose of AAR for which it was created in 1993, is defeated. The Hon’ble Court also took note the international scenario (AAR mechanisms in Australia, New Zealand, United States, Sweden) and observed that the advance ruling system ought to be a dialogue between taxpayers and the revenue authorities for bolstering tax compliance and morale and should not become another stage in the litigation process. The Apex Court thought it appropriate to recommend to the Central Government to consider the efficacy of the advance tax ruling system and make it more comprehensive as a tool for settlement of disputes rather than another tier for litigation. The Court also suggested that a council for Advance Tax Ruling based on the Swedish model and the New Zealand system may be a possible way forward.

The Government must take note of observations and suggestion of the Apex Court and consider making changes in the AAR scheme so that the rulings are issued timely and the appointment and vacancies are not delayed. The average time of disposal of an application takes minimum of 2-3 years which has failed the objective of tax certainty in a timely manner with which it was introduced by the Parliament. The limit for approaching the AAR for residents should be reconsidered and reduced from the present limit of transactions of 100 crores or more.

4. Limitation to be introduced for passing an order in case of non-residents

Section 201 envisages that if a person responsible for deduction of tax at source fails to deduct the whole or any part of the tax or after deduction fails to deposit the same to the credit of the Central Government, then he shall be deemed to be an assessee-in-default.

Section 201(3) provides for a limitation period for passing an order in cases where payments are made to a person resident in India. However, no limitation period or time-limit has been prescribed for passing an order against a person who makes payments to a non-resident. This has led to prolific ligation before various High Court [Delhi – CIT v. NHK Japan Broadcasting Corpn. [2018] [TS-83-HC-2008(DELHI)-O] (Delhi)- Calcutta Bhura Exports Ltd- TS-517-HC-2011(CAL)- contrary decision]. To bring a quietus to the unwanted litigation the Government may consider making a necessary amendment and specifying a time limit for passing an order in cases where payments are made to non-residents.

5. Parity required in certain provisions under the Income Tax Act

1. No prosecution should be launched under Section 276BB if there is a reasonable cause of default.

Section 276B provides for prosecution in cases where the assessee has failed to deposit the tax deducted by him and Section 276BB provides for prosecution in cases where an assessee has failed to deposit the tax collected by him.

Section 278AA provides relief from the prosecution if the assessee proves that there was a reasonable excuse for failure. The said provision is made application to Section 276B and does not include Section 276BB. Since both the provisions deal with similar situations of default in deposit of tax deducted or collected, there must be parity in both and a suitable change should be introduced.

2. Corporate tax rate parity between foreign and domestic companies

The domestic companies in India have effective corporate tax rate of 25.17% [without exemptions and concessions] and those engaged in manufacturing and incorporated after 1 October 2019 pay corporate tax at rate of 17.1% [without exemption/concessions]. However, the effective corporate tax rate for a foreign company is 43.68%. Therefore, Finance Minister may consider having a tax rate parity between domestic and foreign to provide a level playing field or consider reducing the disparity in rates.

Budget 2021 - Stage Set for Overhaul in Business Trust Tax Framework?

This article has been co-authored by Rajesh Mittal (Director) and Yezdi Irani (Manager), EY India.

1. Background of Business Trust

Infrastructure Investment Trusts (“InvIT”) and Real Estate Investment Trusts (“REIT”) [collectively referred to as ‘Business Trusts’] have been one of the fund raising model introduced in the Indian capital market since its introduction by Security Exchange Board of India (“SEBI”), especially for the capital intensive Infrastructure  and Real estate sectors.

With few players listing their portfolio of assets, these models have seen over Rs. 77,700 crores of capital (domestic + foreign) being raised in shorter period of time.  Further, the existing listed Business trust has significant potential to raise further funds from Foreign capital market.  They enhance the depth of India’s capital markets and also assist the Government achieve its target of making India a $5 trillion economy and increase Indian Forex reserve.

Some of the largest Global institutional investors / SWFs / pension funds are backing these fund raising either as sponsors or significant investors.  Listing of Business Trusts provides access to funds for further acquisitions, unlocking value and increase Indian Forex reserve etc.  In the following table, we have captured certain Business Trust that are listed/ unlisted in India or in the process of being set-up:

The draft guidelines were issued in 2008 to facilitate set-up and listing of the Business Trust.  However, Business Trust were not able to take off until 2017, which were facilitated by various regulatory changes introduced in various Regulations. In order to promote investor participation, the Ministry of Finance (‘MoF’) enacted a beneficial taxation regime for Business Trusts through a series of amendments in the Indian Income Tax Act (“the Act”) from Finance Act, 2014 onwards. Following this, the Late Hon. Finance Minister Arun Jaitley’s 2016 Finance Bill introduced a single level of taxation for Business Trusts. These changes that were introduced in tax regimes over the period of time were consistent to certain extent to the global frameworks of taxation of Business Trust.

The Finance Act, 2020 abolished Dividend tax regime (“DDT”) and introduced classical system to tax dividend.  Such change triggered to amend Tax law for dividend distributed by the Business trust to bring in parity with single level taxation, whereby in case if the underlying SPV [defined in section 10(23FC) of the Act] has opted for concessional tax regime under Section 115BAA of the Act, the dividend income distributed by Business Trust is taxable at unitholder level at applicable rates in the hands of the unitholders.  If the SPV continues under the old regime [i.e. SPV’s has not opted for Tax regime under section 115BAA of the Act], the dividend income would be exempt in the hands of the unitholders.

Additionally, Finance Act, 2020, inter-alia, provided that tax on income arising in the hands of ‘Specified Persons[1]’ in the nature of dividend, interest and long-term capital gains arising from investments in Business Trusts in India has been exempted, subject to satisfaction of prescribed conditions.

Also, the existing provisions of the Act which provided for a beneficial tax regime for listed Business Trust, were further extend to unlisted privately placed Business Trust, which is in line with the SEBI Regulations which provides for unlisted InvITs to get the same status as of listed InvITs.

3. Upcoming Union Budget – Opportunity to attract Investor participation and put the Indian Business Trust market competitive on a global scale

To restore the confidence of the developers and investors back in Business Trust structure, some amendments need to be introduced by the Finance Minister for setting the context for future years. The forthcoming Union Budget 2021 provides a perfect platform to the Finance Minister [‘FM’], as our FM walks the tightrope, she faces the onerous task of striking a balance between swings in the economy that have been created due to COVID 19, India's towering aspirations to become a global leader economy and fiscal prudence.

With this background, following changes could be consider to be introduced by FM in this Budget in the Tax and Regulatory regime:

1. Specific exemption for no lapse of losses on migration of SPVs into Business Trusts

Currently, on transfer of shares of SPV by the Sponsor to the Business Trust (of more than 49%) in lieu of units of the Business Trust, brought forward losses of the SPVs get lapsed pursuant to limitation getting triggered under section 79 of the Act.  Further, for an Indian company to qualify as an SPV under the SEBI regulations, the Business Trust is required to hold at least 51% of the equity stake in such company. Thus, Sponsor has to transfer at least 51% stake in the SPV to the Business Trust and the losses of the SPV will always get lapsed on account of such transfer.

Specific exemption under section 79 could be introduced to provide that losses shall not lapse on migration of SPVs into Business Trusts.

2. Holding period for (i) listed units of Business Trust to qualify as long-term capital asset should be reduced to 12 months from 36 months and (ii) for unlisted units of Business Trust to be reduced to 24 months

One of long outstanding demand of the Industry players is to put the level playing field between Listed equity shares and units of Business Trust.  Currently, in case of securities (other than a unit) listed on a recognized stock exchange in India or a unit of the Unit Trust of India or a unit of an equity oriented fund or a zero coupon bond, the holding period for being classified as a long-term capital asset is a period of more than 12 months.

Similarly, in case of share of a company (unlisted), or an immovable property the holding period for being classified as a long-term capital asset is more than 24 months. However, the period of holding for units of listed Business Trust to qualify as long-term capital asset is still more than 36 months.

Reduction of holding period to 12 months for listed units and 24 months for unlisted units will bring parity between equity shares and units and boost investor participation in Business Trusts.

3. No withholding of tax by SPVs on distribution of dividend income or interest on securities to Business Trusts

As per the extant provisions, while dividend income and interest on securities paid by SPVs to Business Trusts has been exempted from tax in the hands of Business Trusts under section 10(23FC) of the Act, the SPV paying such dividend or interest on securities is required to withhold tax on such dividend or interest on securities at the applicable tax rates provided under section 194 and section 193 of the Act respectively.

Section 194A of the Act which is applicable to payment of interest other than on securities provides a specific exemption on interest paid by SPV to Business trust.  However, similar exemption is not provided in section 194 (for dividend income) and interest on securities (section 193) paid by SPVs to Business Trusts.

Thus, there is an inconsistency between the chargeability of dividend income and interest on securities and withholding of tax with respect to such income in the hands of Business Trusts.

Basis first principles, it could be argued that withholding provisions being a machinery mechanism should not trigger as the dividend and interest income itself is not chargeable to income tax in the hands of the Business Trusts. However, in absence of specific exemption under section 194 and section 193, SPVs could be required to withhold taxes on payment made to Business Trust. the existing tax withholding mechanism entails Business Trusts to claim a refund of the taxes withheld and results in a fund / cash blockage on receipt of tax refund and onward distribution to its unitholders.

Providing for an exemption would provide clarity on the withholding tax positions and also would streamline the cash flows for distributions to be made by the Business Trusts to its unitholders.

4. Exemption on withholding of taxes on interest / dividend income payable by InvIT to a unitholder, being a ‘Specified Person’

Tax exemption is provided to a ‘specified person’ on certain incomes received from investments made in the units of an InvIT (subject to fulfilment of certain conditions).

However, as per section 194LBA, Business Trust is required to withhold taxes at the prescribed rates on dividend / interest income distributed to unitholders. No specific exemption has been provided to Business trust to not withhold taxes at the time of distributions made to a person, being a ‘specified person’ under section 10(23FE) of the Act.

Basis first principles, it could be argued that withholding provisions being a machinery mechanism should not trigger as the dividend and interest income itself is not chargeable to income tax in the hands of the Specified Person under section 10(23FE) of the Act. However, in absence of specific exemption under section 194LBA, Business trust could be required to withhold taxes on payment made to Specified person.  Thus, the existing provision of section 194LBA entails  tax deduction which therefore makes Indian investments less attractive because of cash flow leakages.

5. Incentivizing investment in units of Business trust

The Hon’ble Finance Minister may consider providing exemption to a person from long-term capital gains on sale of any asset, provided that he makes an investment in units of Business Trust atleast for a period of 3 years.  Such provision could be similar to the provisions of section 54EC of the Act which extends the benefit provided the investments are made in bonds issued by National Highway Authority of India (NHAI) and Rural Electrification Corporation Limited (REC). Thus, the said exemption would provide much needed liquidity for the primary as well as secondary capital market.

4. Concluding thoughts

The amendments that have been introduced are welcoming steps that has been taken to boost participation of the Investors in Business Trusts.  However, more steps are required to be taken to lift the Indian Business Trust market to compete in the Global market.  Union Budget 2021 is a well timed opportunity to restore the Investor sentiment considering the fact that more another Rs. 24,000 Crores of Business Trust transactions are in pipeline. Some of the upcoming Business Trusts have been tabulated below:

Proposed

Government InvITs

(Disclaimer:  The views and opinions expressed in this article are those of the authors and do not necessarily reflect the view of the firm.)

Budget 2021 – Need to Make IBC More Tax Efficient?

This article has been co-authored by Bharathi Krishnaprasad (Principal Associate), Lakshmikumaran & Sridharan Attorneys.

The Insolvency and Bankruptcy Code (‘IBC’), credited as India’s comprehensive framework to resolving financial distress, is beginning to emerge as an efficacious tool to restore financial viability and recover long pending debts. Since its introduction in December 2016, a total of 4008 Corporate Insolvency Resolution Process (‘CIRP’) have been initiated as at the end of September 2020[1]. As per the Economic Survey, 2020, IBC is credited as having the highest recovery rate of 42.5% as compared to the other resolution and recovery channels like Lok Adalats, DRTs and SARFAESI.

With the budget around the corner, this article attempts to highlight few issues from a direct tax perspective, which if suitably addressed would go a long way in making the CIRP process more effective for ailing businesses.

Exempting waivers of liability from tax

Haircuts on outstanding payables are a necessity in any insolvency resolution of a Corporate Debtor. These payables may include payments to be made to trade creditors, bankers, Government authorities, etc. Waivers of liability are generally taxable under Income Tax Act, if the liability is related to any revenue expenditure for which deduction was already claimed and allowed. Similarly, waivers of borrowing that may be put to use as working capital can also subject to tax. The taxation of amounts waived blurs the attractiveness of liability reduction under CIRP inasmuch as the waived amount effectively gets reduced by the tax component. Similar to the amendment made under Section 79 of the IT Act to permit carry forward of losses of companies under CIRP despite change in shareholding, it may be a welcome move if the lawmakers ponder over amending the existing provisions of the Act to exempt waivers consequent to an approved resolution plan from being subject to Income tax.

Taxability of shares received for consideration less than or more than FMV:

The applicability of anti-avoidance provisions under Section 56(2)(x) and Section 56(2)(viib) of the Income Tax Act, where shares may be issued to a successful Resolution Applicant at price that may be more or less than Fair Market Value (FMV) is another area of concern. The FMV is to be determined as per method prescribed under the Income Tax Rules. The fundamental rules of share valuation of a Corporate Debtor under CIRP is completely different from the principles that may apply in any other circumstances. Hence, applying these provisions that were clearly framed with the intent to plug instances of tax evasion, is likely to burden a Resolution Applicant who has willingly taken the task of settling the liabilities of the Corporate Debtor and reviving its business activities. Considering the spirit of IBC, it may be necessary to spell a carve out from application of Section 56(2)(x) and Section 56(2)(viib) in these circumstances.

Taxability of share transfers at less than FMV:

Taxability of share transfers by existing shareholders of a Corporate Debtor is another area which poses some concern, considering the express language of Section 50CA of the Income Tax Act. Section 50CA, also an anti-abuse provision, is aimed at preventing share transfers of unquoted equity shares designed at avoiding tax implications. Under Section 50CA, the FMV of the shares is deemed to be the consideration received for share transfer, in circumstances where the consideration is less than such FMV. In many cases of share transfers under CIRP, it is likely that the consideration is less than the FMV, triggering application of Section 50CA. Whittling down the rigors of the deeming fiction to exclude share transfers of a Corporate Debtor under IBC would again make the process more tax efficient.

The special nature of the IBC Code has well been emphasized by creating an over arching effect to the provisions of the Code over all the other laws. Certain relaxations in application of the provisions of the Income Tax Act, recognizing the special nature of the Code is something that, that the present Budget, we hope, will provide.

Equalisation Levy and its Fitment into the Constitution

Though equalisation levy, as a concept, has been prevailing in India since its introduction by the Finance Act, 2016, albeit at a relatively small scale, only to be significantly enlarged in its scope by the Finance Act, 2020, one is intrigued to understand the exact nature of such levy, vis-à-vis its fitment within the framework of the Constitution of India (Constitution).                

Setting the context, Chapter VIII of the Finance Act, 2016 had introduced equalisation levy @ 6% on the amount of consideration paid to non-residents for specified services in the form of online advertisement and provision of digital advertising space or other services related to online advertisement. Though not tabled as part of the initial proposals of the Union Budget 2020-21 in the form of the Finance Bill, 2020, yet while enactment of the same by the Parliament, the scope of chargeability of equalisation levy was extended to non-resident e-commerce operators, engaged in the business of online sale of goods and services @ 2% on the value of such online sale of goods and services, through Part VI of the Finance Act, 2020.

The scheme of equalisation levy operates in a manner so as to apply in a scenario where the online supply of goods or services are not effectively connected with any permanent establishment (PE) of the non-resident e-commerce operator in India. Further, where the consideration for online sale of goods or services would be subject to equalisation levy, the same shall be exempt from income tax in India in the hands of the non-resident enterprise under section 10(50) of the Income-tax Act, 1961 (I T Act). It is understood, as explained by the Parliament in the Memorandum explaining the provisions of Finance Bill, 2016, that the enactment of equalisation levy was an effort or attempt on the part of the Indian Government to impose tax on digital transactions, perhaps as an interim measure, pending obtaining consensus amongst countries for finalisation of the scheme for taxation of digital economy, being an active initiative under OECD/ G-20 BEPS Action 1, which would envisage amendment of international tax treaties; and also formulation of new profit allocation methods for the digital economy.

It is in the aforesaid setting that the question arises about the nature and character of the equalisation levy, in the sense, what sort of tax/ duty/ levy it is, vis-à-vis the powers of the Parliament to enact the same under the Union List, i.e. List I, of the Seventh Schedule of the Constitution ? The report issued by the Committee set up by the Central Board of Direct Taxes (CBDT) in February, 2016, for conceptualising the theme of equalisation levy, which incidentally got introduced by the Finance Act, 2016, as mentioned above, states that equalisation levy was conceived of not as an income tax, namely tax on income, but as a tax or levy falling within the purview of Entry 92C and/ or Entry 97 of List I of the Seventh Schedule of the Constitution.

Incidentally, tax on income, other than agricultural income, is levied by the Parliament under Entry 82 of List I of the Seventh Schedule of the Constitution. Entry 92C of List I of the Seventh Schedule of the Constitution, which was introduced by the Constitution (88th Amendment) Act, 2003, though never enforced; and finally omitted by the Constitution (101st Amendment) Act, 2016, enabled the Parliament to enact taxes on services. Thus, with the omission of Entry 92C from List I of the Seventh Schedule of the Constitution in 2016, though the same never came into force in the first instance, equalisation levy can at best, be said to fall only within Entry 97 of List I of the Seventh Schedule of the Constitution, as also claimed by the Committee set up by the CBDT in its report on equalisation levy published in February, 2016, as referred to above. I shall deal with the scope and ambit of Entry 97 of List I of the Seventh Schedule of the Constitution, vis-à-vis the fitment of equalisation levy therein, later on in this article.  

It is elementary that the manner of legislation of equalisation levy, both at the time of its initial introduction in 2016; and its enlargement vide the Finance Act, 2020, is an attempt on the part of the Central Government to override international tax treaties through a unilateral act, since there is no doubt whatsoever that the incomes, which are subject to equalisation levy, constitute “business profits” in the hands of non-resident enterprises under international tax treaties, which unless attributable to PEs of the recipients, cannot be taxed in the host jurisdiction, namely India in the instant case. Thus, unless an amendment was made in this regard in the various tax treaties signed by India, any attempt to levy any income tax on such incomes under the domestic tax laws of India, by expressly stating that the levy of such tax would not be obstructed by any tax treaty, would have been a clear and direct attempt on the part of the Indian Government to breach tax treaties through legislation in domestic tax laws.

What would have been the ramifications of such express breach of international of tax treaties, is a different aspect altogether. In my earlier articles published in Taxsutra on equalisation levy, I had explained that though the Parliament had intended to enact equalisation levy not in the form of income tax, yet inadequate drafting of the legislation actually bestows the said equalisation levy with the character of income tax, as would be evident from the following discussions :

1. The incomes, which are subject to equalisation levy, are exempt in the hands of the non-resident recipients under section 10(50) of the I T Act, thus preventing such non-resident recipients to invoke the provision of tax treaties signed by India with their respective countries of residence.
2. The term, “equalisation levy”, has been defined in section 164(d) of Chapter VIII of the Finance Act, 2016 to mean tax leviable on consideration received for the relevant sales/ services, which are covered by the said levy.
3. Now, the term, “tax” has not been defined in Chapter VIII of the Finance Act, 2016, read with the amendments introduced therein by Part VI of the Finance Act, 2020. Section 164(j) of Chapter VIII of the Finance Act, 2016 provides that words used but not defined in the said Chapter would have the meaning assigned to them, if any, in the I T Act.
4. Section 2(43) of the I T Act defines the term, “tax” to mean income tax, chargeable under the said Act. Therefore, given the manner in which “equalisation levy” has been legislated, the same appears to be nothing else but income tax, which the Parliament is otherwise competent to levy on income under the powers conferred upon it by Articles 245 and 246 of the Constitution, read with Entry 82 of List I of the Seventh Schedule of the Constitution.

Thus, the exemption from income tax separately granted on the impugned incomes in the hands of the non-resident recipients, is actually an empty piece of legislation, as nothing else but income tax is actually charged on the relevant incomes through equalisation levy. In this process, the non-resident recipients of incomes are prevented from invoking the favourable provisions of the relevant tax treaties. Thus, the legislation around equalisation levy in its current form is an unintended express unilateral breach of international tax treaties through amendments made in the domestic tax laws.

The legislation around equalisation levy, as it stands in its current form, has the practical effect, though perhaps unintended on the part of the Parliament, of conveying that notwithstanding anything contained in any international tax treaty signed by India, the impugned items of receipt in the hands of a non-resident taxpayer, where such receipts are not effectively connected with any PE of such non-resident taxpayer, shall be chargeable to income tax in India on gross basis at the rate of 2% or 6%, as the case may be.

Whether the Indian Parliament can unilaterally breach an international tax treaty, which is the result of a bilateral negotiation between two sovereign republics, is an extremely vexed question. Though India is not a signatory to the Vienna Convention of treaties, yet Hon’ble Courts of India have always held that the Indian Government should respect its obligations towards international tax treaties, as per the provisions of the Vienna Convention; and not breach the same through unilateral domestic legislation.

I presume that the legislation around equalisation levy is not an act of express unilateral breach of international tax treaties by the Government of India, though the wordings of the relevant legislation, as referred to above, suggest so. The Government may please consider to make suitable amendments to the legislation around equalisation levy, something which should have been done four years back, in order to unmistakably remove the insignia or character of income tax from the texture of equalisation levy, so that controversies around express breach of obligations around international tax treaties do not come up.

Assuming that the Parliament takes necessary curative measures on the lines discussed above, such that equalisation levy can no longer be equated with income tax, which incidentally was not intended by the Government, as per the report of the Committee set up by the CBDT, as referred to above, then one would be curious to understand the exact nature of the impugned levy, vis-à-vis its setting within Entry 97 of List I of the Seventh Schedule of the Constitution.

Entry 97 of List I of the Seventh Schedule of the Constitution, which is generally referred to as the residuary clause, enables the Parliament to enact laws on any other matter, including taxation, not enumerated in List II, i.e. the State List; or List III, i.e. the Concurrent List, of the Seventh Schedule of the Constitution. The Honn’ble Supreme Court has held that once it is established that the taxing power claimed by the Parliament under Entry 97 is not covered by any Entry in List II or List III of the Seventh Schedule of the Constitution, it is competent for the Parliament to combine its powers under Entry 97 with some other powers, which legitimately belong to the Parliament exclusively under some other Entry of List I [refer International Tourist Corporation vs. State of Haryana – AIR 1981 SC 774].

Thus, in case any other Entry of List I of the Seventh Schedule of the Constitution provides for legislation by the Parliament for imposing taxes, duties, etc., similar to that of equalisation levy, then the Parliament would still be permitted to enact equalisation levy under Entry 97 of the Seventh Schedule of the Constitution. However, the doubt or debate is elsewhere, as explained below.

In so far as a non-resident enterprise may sell goods or services on an offshore basis for consumption in India, namely without such sale of goods or services being effectively connected with any PE of the non-resident enterprise in India, there already exist legislations for imposing taxes or duties on the value of such goods or services. Offshore sale of goods by a non-resident enterprise, amounting to importation thereof by the purchaser in India, attracts customs duty levied by the Parliament under Entry 83 of List I of the Seventh Schedule of the Constitution. Similarly, supply of services by a non-resident enterprise on an offshore basis, which are consumed in India, attracts integrated goods and service tax (IGST) levied by the Parliament under Article 246-A of the Constitution. It is important to note that such customs duty and IGST are levied irrespective of whether or not the goods or services, as the case may be, are sold by the non-resident enterprise online or through traditional manner of correspondences between the supplier and purchaser.

Thus, though the Parliament is otherwise competent to enact equalisation levy on online supply of goods or services by a non-resident enterprise on an offshore basis, per se under Entry 97 of List I of the Seventh Schedule of the Constitution, in the form of an indirect tax and not income tax, as also claimed by the Committee set up by the CBDT, the question arises that since such events of online supply of goods or services by a non-resident enterprise on an offshore basis are already subject to indirect taxes in the form of customs duty or IGST, as the case may be, what then is the real character of equalisation levy, namely what event/ activity triggers such levy; and further, what purpose does it intend to serve, except for dispensing with the levy of income tax on the amount of income embedded therein, as per the provisions of Entry 82 of List I of the Seventh Schedule of the Constitution, so that the non-resident enterprise may not obtain relief from such income tax by resorting to the favourable provisions of international tax treaties ?

Would equalisation levy be then regarded as additional imposts of customs duty or IGST, where the offshore supply of goods or services, as the case may be, by a non-resident enterprise for consumption in India, is made online ? Would such equalisation levy then infringe upon the overall ecosystem of the new regime of GST ? These are very important questions for the Parliament to deliberate upon and clarify. Unfortunately, no meaningful debate or discussions have ever taken place in the Parliament with respect to the nature, character and validity of equalisation levy from the perspective of the Constitution.

It would be immensely helpful if the Central Government would provide necessary clarifications with respect to the above issues while tabling the forthcoming Union Budget; or even otherwise. It may be noted that in absence of a mechanism for obtaining credit for equalisation levy in their countries of residence, the non-resident taxpayers are actually passing on their liabilities towards equalisation levy upon the consumers in India, as a result of which, Indian consumers are actually bearing the burden of such levy. Thus, the efficacy of introducing interim measures of the above nature, pending consensus amongst countries for adopting a workable solution for digital taxation under bilateral tax treaties, creates an environment of debate; and therefore providing clarifications regarding the basic nature and character of equalisation levy within the contours of the Constitution becomes that much more important for the Government.

Budget 2021 - Expectations of Banks & Financial Institutions

The year 2020 was a challenging year for countries across the globe. Many countries are facing severe challenges in bringing back their economy to normalcy. India was no exception and is also struggling to rebuild its economy, while the intensity of the pandemic seems to be tapering off. In India, while the organized sector seems to be doing well, the unorganized and marginal business men and the community at large seems to merely cope up.

Amidst the challenging times for the Indian and global economies, the Hon’ble Union Finance Minister, Smt. Nirmala Sitharaman, will present the first paperless Union Budget on February 1, 2021. The Banking and financial institutions are considered as the backbones of Indian economy and the Hon’ble Finance Minister has a tough time for not only ensuring that there is a revival in the credit system, but also ensuring that there is minimal bad loan exposure. The banks and NBFCs have already made number of recommendations. In this article, the author has sought to highlight some of the tax expectations.

a)  Taxation of interest income

Banks and NBFCs are subject to RBI regulations. Under these regulations, loan or an advance, where interest and / or instalment of principal remain overdue for a period of more than 90 days is considered as a ‘Non-performing asset’ (‘NPA’). As per these regulations, interest income from NPAs is recognized only at the time of receipt of interest. The Apex Court in the case of Vasisth Chay Vyapar Ltd. and subsequently, the Bombay High Court in the case of Bajaj Finance Limited has held that NBFCs are governed by the RBI directions and as per the real income theory, such interest income on NPA is not taxable until it is received.

Under Section 43D of the Income Tax Act, 1961 (‘IT Act’) (applicable to banks and certain financial institutions), interest income on NPAs is charged to tax in the year in which the income (on certain categories of assets) is credited to the profit and loss account or on receipt of income, whichever is earlier. Nature of sticky assets /loans (i.e. NPAs- as per the RBI), as provided in Rules 6EA and 6EB, at the time of introduction of section 43D, were in sync with the RBI prudential norms. However, thereafter, these rules have not kept in step with the changes made by RBI (for example, loan outstanding for more than 180 days is considered as NPA under these Rules, whereas RBI relaxed the NPA norms and provided for 90 days period). This has led to controversy between the taxpayer and the tax authorities with respect to the year of taxation. Additionally, it would be important to see the impact of IndAS on taxation of such interest, wherein NBFCs are now required to recognize in their financial statements interest income beyond the period of 90 days, subject to certain conditions. Thus, there is an expectation to re-align the provisions of the IT Act with the RBI prudential norms.  

b) Extending deduction for rural advances given by urban branches

Under section 36(1)(viia), a bank is entitled to claim deduction of 10% of the aggregate average advances made by the ‘rural branch’ of such bank. A ‘rural branch’ means a branch of a scheduled bank, situated in a place with a population not exceeding 10,000, according to the last preceding census. The legislative intent (in the year 1979) was to promote rural banking and to assist the scheduled commercial banks in making adequate provisions from their current income to provide for risk in relation to rural advances. There has been substantial improvement in rural financing over time. In fact, many times, urban branches of many big banks provide rural advances (sometimes through Business Correspondent (‘BC’)).

As per the RBI, BCs are retail agents engaged by banks for providing banking services at locations, other than a bank branch / ATM. BCs are permitted to perform a variety of activities, which include identification of borrowers, processing of loan applications, etc. BCs play a vital role in enabling access to banking services, to the poor & needy. The role of BC is also crucial for the Government, RBI & banks to achieve the goal of financial inclusion and to ensure that the benefits of the same percolate to the low income groups, having low financial literacy.

With the help of these BCs, the urban branches are enabled to provide rural advances. Since the intention of the legislation was to give deduction for rural advances, it is expected that such deduction should also be extended to rural advances provided by urban branches of bank.

C) Allowability of ‘Technical write offs’

Under section 36(1)(vii), the amount of any ‘bad debt or part thereof’, which is written off as irrecoverable in the accounts of the taxpayer, is allowable as deduction, subject to fulfilment of certain other conditions. The question is whether ‘technical write-offs’ are allowable as deduction. The RBI considers the ‘technical write-offs’ (also termed as ‘prudential write- offs’) of bad loans that have been written off at the head office level of the bank, but remain as bad loans in the books of branches. Recovery of such loans continues at the branch level. From the accounting perspective, the amount is debited to the profit and loss account and correspondingly shown on liability side – mapped to the customer advance account. At the year end, the balance of ‘technical write-off’ (reflected on the liability side) is reduced from the gross debtors and the net loans and advances are presented in the balance sheet. ‘Technical write-offs’ are towards bad loans. However, in terms of accounting, the individual debtor is not reduced and hence, the question is whether the same is allowable as deduction under section 36(1)(vii) of the Act. The Bangalore Tribunal in the case of Syndicate Bank (ITA No. 680/Bang/2012) had allowed deduction under section 36(1)(vii), following the Apex Court decision in the case of Vijaya Bank (TS-120-SC-2010), wherein it was held that write off of balances of individual debtors account is not necessary. Infact, it should be also borne in mind that at branch level, it is a memorandum account. It is preferable that this position is suitably reflected in a clarificatory amendment to mitigate any future unwarranted controversy in the matter of claiming technical write offs as bad debts.

d) Exemption from Tax Deduction at Source (‘TDS’) provisions

Interest payable to a NBFC is subject to TDS under 194A, whereas interest payable to a bank is not subjected to TDS. To provide a level playing field and to minimise compliance requirements, it is expected that the Government should extend the exemption provided in section 194A (just like banks) to NBFCs as well.

Every banking company is required to deduct TDS @ 2% under section 194N on cash withdrawal exceeding Rs. 10 million by the recipient. However, cash withdrawal by the banks and any BC of a bank is exempted from TDS. A controversy has arisen as to whether the bank should deduct tax under section 194N, where cash is withdrawn by a BC of some other bank (as an illustration, whether Bank ‘A’ should deduct tax on cash withdrawn from an account maintained with them by a BC of Bank ‘B’). The fact remains that the cash is withdrawn by BC to provide facilities to the customers, on behalf of the bank and is towards BC services only. Accordingly, in the exclusion list, in the section, a clarification is required to replace the words “any business correspondent of a Banking company” with the words “any business correspondent of any banking company”. In other words,, it is expected that BCs, acting on behalf of any bank, should be also exempted from this TDS provision.

e) Extending exemption of GST provisions to services rendered by BC

GST @ 18% is leviable on services of BCs & business facilitators, who provide intermediary services to banks. However, GST is exempted, if the services are provided with respect to accounts in a rural branch of the bank.

In some cases, the urban branches also provide rural advances through the BCs, whose services are subject to GST. Further, banks get input tax credit of 50% thereof. Thus, there is increase in cost of lending to rural areas. It is therefore fervently hoped that Government would exempt services of BCs & business facilitators from GST levy for services rendered in relation to rural advances.

The Government has a tough time this year in view of COVID 2019. The Finance Minister usually has the unenviable task, more so this year in view of COVID 2019, of balancing revenue and expenditure and prioritise allocations to different sectors; needless to say, there would be pulls from all ends for the collective aim of all being to bring the economy on track, at the earliest. Coming State elections add their woes for the FM. The emphasis it seems would be on the expenditure side and the agricultural front (to counter the challenge of the farmers’ agitation). So, one expects certain reliefs with strict governance.  We can only wait and see how the budget turns out and how many industry expectations are met by the Hon’ble Finance Minister in the forthcoming Budget.

(The views expressed in the article are author’s personal views.)

Budget 2021 – Expectations of the Real Estate Stakeholders

This article has been co-authored by Hiten Ved [Counsel (Tax)], Begur & Partners.

The real estate sector has undergone a significant turnaround during the year of the outburst of the global pandemic.  This sector is heavily driven by government policy and availability of investible surplus income in the hands of common people. The sector generates about 14 % of the jobs in the economy, contributing to 7 % of the GDP which is expected to increase to 13% by 2025. Given the significant importance of this sector from an overall economic development perspective, industry expects several key policy measures in the upcoming Budget. Following are some of the long pending policy expectations by the developers as well as the home buyers from this sector:

1.     For Developers

1. Demand for an infrastructure status - The real estate sector not only has a significant direct contribution of around 6-7 % of the GDP but also has several socio-economic implications on the economy and the society. Hence, there is a demand that this sector be accorded the infrastructure status and be included in the priority lending list of banks. Currently, only the affordable housing sector has been granted such status.
2. Inclusion of the real estate sector within the purview of Section 72A - The applicability of Section 72A of the Income Tax Act, 1961 (Act) in relation to relaxations with respect to the carry forward and set off of losses in certain scenarios should be extended to bring within its ambit the entities engaged in construction and development of real estate.
3. Relaxation in taxability of income from stock held by a real estate developer on notional basis - Under Section 23(5) of the Act, where the developer is unable to sell the inventory within a period of 2 years from receipt of Occupation Certificate, the tax is levied on the developers on the notional annual value of such inventory. Given the genuine hardships faced by the developers in selling their inventory due to the global pandemic, an appropriate relaxation in applicability of the aforesaid Section maybe granted.
4. Reduction in tax rates for businesses within the infrastructure and real estate sector - The concessional tax rate of 22% currently prescribed for corporates may also be extended to the firms and LLPs engaged in business activities within the infrastructure and real estate sector. This would bring such LLPs and firms at par with the company structure and widen the avenues available for the developers to structure their development activities.
5. Incentives for affordable housing under Section 80-IBA of the Act - The tax holiday under Section 80-IBA of the Act, viz. the 100 % deduction on profits earned by developers of affordable housing projects that have been approved till March 2021, must be extended to projects approved up to March 31, 2023.
6. Impetus for Joint Development Agreements (JDA) - An amendment must be made to Section 45(5A) of the Act in relation to deferment of taxability of gains arising from transfer of capital asset under JDA to extend its applicability to all taxpayers (viz. companies, firms, LLP etc.)  and not restricting it to individuals and Hindu Undivided Families (HUFs). Widening such applicability will give an impetus to JDAs and thereby boost the real estate sector.
7. Relaxation in GST - Relaxation in current levy of GST on developers for joint development transactions on Transfer of Development Rights (TDR) could bolster the development activities.

2.     For Home Buyers

1. Separate deduction for principal repayment of housing loan - Currently, the deduction for principal repayment of home loan is subsumed within the aggregate limit of INR 1,50,000 available under Section 80C of the Act for making eligible investments. The home buyers expect to carve out the principal repayment of home loan from ambit of Section 80C and a separate deduction be granted for principal repayment of housing loan subject to an enhanced limit of INR 5,00,000.
2. Further extension of timeline for interest on home loan deduction under Section 80 EEA - Under Section 80EEA of the Act, the borrower can avail an enhanced deduction of up to INR 1,50,000 for interest on home loan subject to the condition that the home loan is sanctioned during the period 1st April 2019 to March 31, 2021. The government should consider granting further extension of one year (i.e. include home loans sanctioned till March 31, 2022) for availing the benefit under this section.
3. Tax rebate for interest on home loan - The current ceiling of INR 2,00,000 for deduction of interest on housing loans while computing income from house property under Section 24 of the Act be removed or enhanced significantly.
4. Amendment in Section 54 and 54 F of the Act – Section 54 and 54 F provides for time limit of 3 years for investment of capital gains in new house (construction / purchase) to avail the deduction / exemption. In case of purchase of a new property, even investment made by purchasing a property within one year before the sale of the asset is eligible for claiming the aforesaid benefit. The time limit for investment of gains should be increased from 3 years to 5 years. Further, the benefit of investing one year prior to the sale should be also extended to construction of house.
5. Reduction in holding period of immovable properties – To qualify as a long-term capital asset, the holding period prescribed under Section 2(42A) of the Act in case of an immovable property be reduced from the existing 36 months to 24 months.  Consequential amendments for reducing the holding period of immovable property from 3 to 2 years should be made in Sections 54, 54B, 54D, and 54F of the Act, in line with the amendment in Section 2(42A) of the said Act.
6. Relaxations for Real Estate Investment Trusts (REITs) - The holding period for units of a REIT for qualifying as long-term capital assets be reduced from 36 months to 12 months to bring it in line with listed equity shares.
7. GST waiver for under-construction homes - A limited period waiver of GST on under construction property is recommended in order to reduce the overall property cost and push the demand for under-construction homes bringing it at par with the ready possession property (which are not currently subject to GST).
8. Removal of price cap on affordable housing – A cap has been set on the carpet area of affordable housing at 90 square metres in non-metropolitan areas and 60 square metres in metropolitan cities along with a price cap on the property value at INR 45,00,000. Since houses of the same carpet area are priced higher in metropolitan cities as opposed to non-metropolitan cities and towns, the aforementioned price cap applicable to an affordable house must be removed.
9. Extension of the relaxation provided by the stimulus package - Considering that there are several cases where the market-determined price of residential houses is much lower than the prevailing circle rate, the government should look at extending the relaxation provided in the stimulus package beyond June 30, 2021, which permits residential houses up to INR 2,00,00,000 to be sold at a price that is 20 % lower than the prevailing circle rate. Additionally, the price of houses eligible for this relaxation should be increased to INR 5,00,00,000 from the current INR 2,00,00,000 to help liquidate unsold inventory.

The above expectations, if fulfilled, shall go a long way to give impetus to the government’s agenda of “Housing for All by 2022” and ease liquidity for developers as well as home buyers. These measures would also help reviving the tumbled real estate sector from the damages caused by the COVID 19 pandemic.

Aligning Tax Legislations to the “New Normal” - the Need of the Hour

This article has been co-authored by Prashant Bhojwani.

Recently, the Organisation for Economic Co-operation and Development (OECD) revisited its earlier guidance of April 2020 issued on impact of COVID-19 pandemic on tax treaties. Unprecedented measures have been imposed by various governments including travel restrictions and curtailment of business operations (referred as public health measures) due to pandemic during most of 2020. This situation is expected to continue in 2021 at least for some months.

The OECD guidance is intended to provide more certainty to taxpayers and reflects a general approach of jurisdictions. It also provides examples of the manner in which some jurisdictions have addressed the pandemic impact on tax situations of individuals and business enterprises. The objective is to avoid double taxation but should not be relied on to create instances of non-taxation.

In the past year 2020, enterprises have witnessed severe business disruptions on account of travel restrictions, immobility of individuals and temporary closure of business premises, work from home etc. and the above can have severe tax consequences for businesses.

The updated guidance considers some additional facts which were not addressed in detail in April 2020. The guidance is sought to apply only to situations arising due to the pandemic and public health measures in place.

The key takeaways from the OECD updated guidance are summarized below for an important trigger for taxation viz Permanent Establishment (PE):

Concerns regarding PE creation

The employees could be dislocated from the jurisdiction in which they work regularly, and may be compelled to work from home, which may be in another jurisdiction. In such a scenario, the foreign enterprise (i.e. employer) may have to deal with creation of a PE on account of the home office of the employee, triggering for businesses new tax filing requirements, tax obligations, etc.

This exceptional and temporary change of location from where employees exercise their employment on account of the pandemic, should not create a new PE for the employer. Similarly, temporary conclusion of contracts from the home of the employees or agents on account of the pandemic should not create PE for the businesses in that jurisdiction. Also, a construction site should not be regarded as ceasing to exist when work is temporarily interrupted (dealt in more detail later). But jurisdictions should consider “stopping the clock” for determining the PE threshold for periods during which operations were suspended on account of public health measures.

In this context, the tax authorities of a number of countries (e.g. Australia, Canada, Germany) have issued guidance on whether change in work practices or places of work (work from home) could result in a PE. This has been welcomed by businesses as it provides greater certainty in respect of tax consequences. As an illustration, guidance issued by few countries are summarised below:

Australia

The effects of the pandemic will not alone result in the foreign enterprise having an Australian PE, if the following are met:

• The foreign enterprise did not have a PE in Australia before the effects of COVID-19.
• There are no other changes in the enterprise’s circumstances.
• The unplanned presence of employees in Australia is a short-term result of them being temporarily relocated or restricted in their travel because of COVID-19.

The guidance confirms that it will not apply compliance resources to determine if an enterprise has a PE in Australia if:

• The enterprise did not otherwise have a PE in Australia before the effects of COVID-19.
• The temporary presence of employees in Australia continues to solely be as a result of COVID-19 related travel restrictions.
• Those employees temporarily in Australia will relocate overseas as soon as practicable following the relaxation of international travel restrictions.
• The enterprise has not recognized those employees as creating a PE or generating Australian source income in Australia for the purpose of the tax laws of another jurisdiction.

The above guidance is applicable until 31 January 2021.

Austria

If an Austrian employee of a foreign enterprise carries out his work in Austrian home office during the pandemic due to the measures recommended by the respective governments, this is due to force majeure. Therefore, in view of the extraordinary nature of the crisis – and provided that work in the home office does not become the norm – there should be no PE for the foreign enterprise, because the home office lacks sufficient disposal of the enterprise over the home office. In addition, the employer provides an office which in normal circumstances is available to its employees.

Temporary interruptions of construction sites due to the pandemic should in principle not lead to suspension of deadline of Article 5(3) of OECD model - subject to any deviating bilateral agreement.

Canada

A resident enterprise from a treaty country should not be considered to have a PE in Canada solely because:

• Its employees perform their employment duties in Canada on account of travel restrictions, being in force.  
• A dependent agent concludes contracts in Canada on behalf of the foreign enterprise while the travel restrictions are in force, provided that such activities are limited to that period and would not have been performed in Canada but for the travel restrictions.

Germany

An interruption of construction and installation work caused by COVID-19 will not be counted for purposes of time threshold of PE under Article 5(3), provided that:

• The duration of interruption is at least two weeks,
• The personnel of the enterprise (or any commissioned personnel) has been withdrawn from the construction site or have left it, and
• The relevant income will be taxed, e.g. in the jurisdiction of residence of the enterprise or its personnel, where the suspension of the lapse of time results in the enterprise not having a PE in Germany.

Germany would ignore the time of interruption, but it would combine the time spent before and after the interruption (so that PE duration test does not start afresh after the pandemic-related interruption).

Similar guidance provided by other countries like Greece, Ireland, New Zealand, UK, US have been extensively given by OECD in the revised guidance.

Home office

Paras 14 to 19 of the updated OECD guidance deals with specific comments on work from home due to the pandemic. Some of key points emerging from the above are:

• A home office intermittently used was not considered PE earlier since it was not at the disposal of an enterprise. However, if it was used on continuous basis, it may be regarded as PE. During the pandemic, individuals working from home remotely are doing so as a result of public health measure. It being an extraordinary event should not be considered as giving rise to a PE since it lacks sufficient degree of permanency or continuity or because it is not at disposal of the enterprise.
• If however an individual continues to work from home after cessation of public health measures imposed, the home office may be considered to have a certain degree of permanency, but a further factual examination is required to determine whether the home office is at the disposal of the enterprise.
• In case a cross-border worker undertakes most of his work from his home situated in one jurisdiction, rather then, an office made available to him in another jurisdiction, the home should not be considered at the disposal of the enterprise as such enterprise does not require the home to be used for its business activities.
• To conclude, individuals tele-working from home due to imposition of public health measure by the government to prevent spread of COVID-19 should not create a fixed place PE.

Agency PE concerns

• Similar to above, if an employee of an agent temporarily working from home could have given rise to a dependent agent PE if he habitually concludes contracts therefrom.
• Para 23 and 24 of the revised guidance addresses the above and seeks to suggest that if he is compelled to work from his home, the agent’s activity should not be considered as ‘habitual’ if they are due to exceptional situations working from home as a public health measure imposed by the government. Consequently, such working by an agent’s employee should not constitute a dependent agent PE provided of course the employee does not continue to do so after stringent measures cease to apply.

Construction PE concerns

• A construction site is not regarded as ceasing to exist when work is temporarily discontinued. Jurisdictions may consider certain periods of a type of interruption where operations are prevented, on account of public health measure imposed by the government where the site is located, to be reduced while computing the time period threshold for PE.

To summarize, while the OECD and different countries have come up with guidance on occurrence or otherwise of PE in view of restrictions imposed by jurisdictions as part of public health measures, India needs to come up with it’s views on how it wants to deal with these situations from a PE perspective. If it agrees to the above, appropriate guidance should be issued sooner rather than later. Also, since we have detailed explanations/ definitions on “business connection” under section 9 of the Income-tax Act, 1961 and PE in section 92F of the Income-tax Act, 1961, appropriate amendments/ clarifications ought to be given to guide business enterprises from non-treaty countries. This is the only way in which we can demonstrate that we are aligning ourselves globally to changing economic environment due to the unprecedented impact of COVID-19 measures.

The views expressed above are personal and for information purposes only.

Union Budget 2021 – A ‘Shot’ in the Arm that the Aam Aadmi Keenly Awaits

This article has been co-authored by Aabhishek Khurana (Manager) and Stuti Parikh (Senior Consultant), Ernst & Young LLP.

It’s ‘that’ time of the year again when the print/electronic and these days even the social media are flooded with plethora of news pieces encompassing the taxpayers’ eternally sky-high Budget anticipations. As our Finance Minister, Mrs Nirmala Sitharaman, walks the tightrope and braces herself to present the Union Budget 2021, widely projected to be the most revolutionary and path-breaking Budget of all times, she has her task cut out as she confronts a gruelling task of jump starting the growth engine (brought to a standstill by the brutal pandemic and now starting to display signs of revival) as well as appeasing the common man with some anticipated tax sops keeping fiscal prudence in mind.

There’s no denying that the pandemic has left an indelible scar on everyone’s life, and taking cognisance of this, the FM has already proclaimed that this Budget would be ‘one like never before’ – leaving taxpayers gasping and contemplating as to what’s in store for them this time around and whether the FM would don the Robinhood hat by loosening her purse strings for them.

On the recent occasion of the symbolic and auspicious 'Halwa Ceremony', which marks the commencement of the final lap of the Budget preparation, the Government (in what could be said to be really unprecedented) pronounced that Budget 2021 will be the first Budget in India’s history to be delivered in a paperless format (to shun the spread of COVID-19) and launched the 'Union Budget Mobile App' for hassle-free access to the Budget documents (yes, the Bahi-khata synonymous with our FM has been dumped this year). One only hopes that this transformation is a gateway for some breakthrough reforms, even as the Government grapples with a severely restrained fiscal bandwidth.

With the above backdrop, enumerated below are some of our expectations for the D-day:

• Amendments in the personal income-tax slabs and levy of a temporary COVID cess

One of the key proposals unfurled by the FM in the last year’s Budget was the introduction of the New Concessional Tax Regime, which aimed to simplify the tax laws for individuals at large. By virtue of this provision, individual taxpayers now have an option to choose reduced tax rates, if they were to forego certain tax exemptions/deductions [for instance - standard deduction of INR 50,000 and Profession tax, exemption available in respect of House Rent Allowance/Leave Travel Allowance, deduction towards interest on housing loan for self-occupied/vacant property and no set-off of House Property losses with any other income head, key Chapter VI-A deductions (barring a couple of exceptions) etc.].

While this was a great move from the Government’s side, admittedly, this provision was beneficial to only a select sect of taxpayers, who do not claim some or most of the aforementioned exemptions/deductions or say wanting more cash in-hand (not making any insurance payments, investment in PF/PPF etc.). Also, a drawback of this provision is that it does not incentivise savings/investments, which may adversely impact such people in the long run.

Additionally, such regime is not very lucrative for taxpayers falling in the higher income slabs and having tax-saving investments eligible for deductions/exemptions i.e. they are still better off under the old tax regime.

With the pandemic far from over and our tax structure not being in sync with inflation, there is a strong need to provide an immediate relief in the form of enhancement of basic exemption limit (say, increase the same to INR 3.5/4 lakhs, if INR 5 lakhs seems exorbitant given the fiscal situation) along with realignment of the existing slab rates for such individuals – solving the dual purpose of bringing cheer to the taxpayers’ faces as well as stimulating consumption/fostering investments. Here, the Government could consider paying heed to the suggestions of the taskforce on the Direct Tax Code, which had last year advocated a considerable revamp of the present-day tax slabs.

Also, with the New Labour Codes on the anvil and the rumours around the ‘monthly take home’ of the salaried janta getting lessened, such a move will certainly act as a solace for these individuals – some of them already marred with salary cuts/Nil or negligible annual increments as an aftermath of the pandemic.

Speculations are also rife that the FM could enhance the prevalent Health and Education Cess from 4% to 5%/6% or levy a one-time COVID cess on HNIs to fund the Government’s vaccine/healthcare expenditure. While this measure may not be appreciated by the HNIs (already having the perception of being taxed at one of the highest personal tax rates worldwide), fiscal prudence may tip the FM’s hand to go for this option to raise some additional taxes without impacting the lower income earners.  It will be important to ensure that any such measure even if introduced is purely temporary and this should be clearly spelt out and followed in practice.

• Tax relief for employees ‘working from home’

‘Work from home’ has become the ‘new normal’ in the wake of the pandemic and is expected to last longer than initially forecasted. Some IT/ITeS giants have already extended this option to their employees till the end of 2021 from the employees’ safety standpoint and to bring down the allied costs to an extent.

Whilst the world has over a period of time realised that working from home can be convenient, there is an element of additional expenditure associated with it to more or less replicate the office environment at home to sustain the same productivity level(s). Higher broadband speeds, purchase of desks and chairs, continuous power supply/back-up, surge in the electricity/cell phone bills etc. are a few examples of such incremental outgo.

Compensation structures endowed with components such as House Rent Allowance (with many employees surrendering their rented places and moving to their hometowns), food coupons/vouchers, fuel expenditure for official travel etc. have been rendered ineffectual from a personal tax perspective under the work from home era, which has led to the concerned employees ultimately paying taxes on the whole amount received towards these components.

Today, there are no explicit provisions under the extant Indian tax laws that govern any exemption/deduction that could be availed by the employees to facilitate work from home, which in a way is discriminatory when compared to the individuals having business/professional income – who are allowed full deduction of the expenditure that is incurred to earn such income. The pandemic-induced lockdown and the ensuing restrictions have ensured that the salaried class and the business/profession class spent on office infrastructure alike.

Some benevolent employers have provided allowances/reimbursements/even assets in a handful of cases to fund this surplus cash outflow from the employees’ side. However, in the absence of any clarity under the prevailing tax laws or any guidance issued by the Government and in view of the onerous ramifications that the employers could face in the form of interest/penal exposure arising on account of short/non-deduction of taxes, organisations have out of abundant caution acted conservatively by largely regarding these amounts as taxable in the employees’ hands.

There is a dire need for the Government to take a due note of this (some countries like Canada, the Netherlands and the UK have already rolled out tax reliefs to their nationals in this space) and it is expected that the FM could grant a fresh set of reliefs in the form of some rebate or a fixed exemption/deduction for such work from home related expenses in this Budget.

Alternatively, the FM could look at augmenting the Standard deduction threshold to at least double of what it is today (INR 1 lakh from INR 50,000), in view of the current deduction not being reflective of the ground reality.

• Extension of the Leave Travel Concession (‘LTC’) Cash Voucher Scheme

Hospitality and Travel & Tourism have been the worst hit sectors on account of the pandemic. With a focus towards spurring consumption choked by the lockdown and granting tax relief to the salaried individuals (who could not travel due to the pandemic and would have otherwise lost their annual LTA exemption), a step in the right direction from the Government was the formulation of the novel LTC Cash Voucher Scheme. The said Scheme (first introduced for the Central Government employees and later extended to the non-Central Government employees) entails admissibility of tax exemption to employees, who purchase eligible goods or services with a GST rate of 12% and above between 12 October 2020 to 31 March 2021 via digital payment modes, in lieu of foregoing one exemption on travel cost while being on leave. The exemption is available subject to certain specified conditions and the maximum exemption is capped at INR 36,000 per person as deemed LTC fare (for a round trip) for the non-Central Government employees – with one having to spend 3 times of the deemed fare to claim the desired exemption.

This Scheme has been fairly popular with a lot of private sector corporates, which have extended this benefit to their employees, however at the same time, there are a number of organisations that have not yet offered this substitute to their employees due to lack of legislative amendments and ambiguity around the implementation of the Scheme for the private sector.

The ask for the FM here would be to bring in the requisite changes in the law vide the upcoming Budget to address the uncertainly surrounding this Scheme. Moreover, to amplify the benefits available thereunder and provide further thrust to the consumption led demand till the abovementioned sectors witness pre-COVID normalcy, the FM should prolong this Scheme beyond 31 March 2021 – say, extend it up to 31 December 2021 in line with the current block period end.

• Issuance of adequate clarifications related to residency for the stranded individuals

For FY 2019-20, the CBDT had issued a notification relaxing the methodology for computation of ‘number of days’ of physical stay in India for the determination of residential status of individuals, who were on a visit to India and got stranded here due to the lockdown and the suspension of international flight operations.

Considering the stretched travel restrictions and international flights not being fully operational yet, the Government should announce similar relaxations for FY 2020-21 too with reference to such stranded individuals. One must not forget that tax residency has a direct bearing on the scope of taxation for an individual, and hence such a clarification from the Government’s side becomes super essential.

If provided, this would be embraced as a welcome step by such individuals (who have been jittery due to there not being any express guidance from the Government’s end) and definitely make them heave a sigh of relief.

On a slightly different footing, another longstanding demand has been that the short stay exemption available under the domestic tax laws should be extended to Non-resident Indian citizens (available only to foreign citizens at the moment) on the same lines as the Dependent Personal Services Article of various tax treaties (where treaty residency and not the citizenship is pertinent) on principles of parity and to avoid hardship in bonafide cases.

• Deduction of expenditure incurred on medical treatment

With a view to grant relief to taxpayers who or whose families are/were infected with the virus and who have incurred humongous expenditure on medical treatment, the Government could grant additional deduction of the medical expenses incurred for the treatment of taxpayers and their families.

Currently, the deduction towards medical expenditure is available only with respect to senior citizens not having any health insurance cover. Having regard to the sky-rocketing medical costs, the Government should consider extending the same to all taxpayers regardless of any pre-requisites like existent health insurance, age limit etc. and also raising the prevalent deduction limits to bring them on a level playing field with the mounting expenditure levels.

• Hiking the threshold of deduction under sections 80C and 80E

The deduction limit under section 80C was last enhanced way back in July 2014 and has remained stagnant since then. Due to the not so significant upper cap, various investment schemes have lost their sheen. Raising this limit with targeted investments into priority sectors will boost savings and encourage investments by people. With an increase in the limit to at least INR 2.5 lakhs from the present limit, a salaried individual could enjoy a considerable increase in tax-free income.

This move would incentivise savings by inculcating healthy investment habits, and thus become a win-win situation for the taxpayers and the Government (eg - infrastructure is one sector just waking up from slumber and savings could be directed into infrastructure linked instruments – somewhat similar to the erstwhile deduction available under section 80CCF pertaining to infrastructure bonds).

Another vital expenditure is the interest cost incurred for higher education, which has exponentially risen over the years. The window of deduction period on education loan currently stands at 8 years. Akin to a housing loan, it should be available for the full tenure of the loan.

• Rationalising the LTCG tax regime

One of the buzzes in the run-up to this Budget has been that the Government may increase the tax rate on the LTCG arising on sale of listed equity shares/equity oriented mutual funds/units of a business trust (currently taxed at 10% beyond INR 1 lakh without indexation) to garner more tax revenue. This move will clearly deal a blow to the charm of equities, which have been shining brightly of late and have elevated to lifetime highs.

Here, before tinkering with the present tax rate, the Government should take into account that the taxes arising on LTCG are also accompanied with ancillary transaction charges/taxes like Securities Transaction Tax, Stamp Duty etc.

If the Government were to indeed increase the tax rate beyond 10%, it should consider raising the extant tax-free LTCG ceiling from INR 1 lakh to INR 2 lakhs as a minimum.

On a related note, the holding period to qualify as ‘long-term’ for equity funds is 12 months, 24 months for immovable property and 36 months for gold and all other mutual/overseas funds (including units of business trusts i.e. REITs/InvITs, which have started gaining excellent traction lately). Even the tax rates differ in some cases. It is imperative that the holding period across various asset classes be standardised and uniformity in tax rates be brought in to attract greater retail investor participation in the debt/gold/REIT & InvIT markets.

The Government has shown admirable resilience and done a tremendous job of tackling the colossal COVID crisis in these unprecedented times via provision of time to time stimulus packages. It has vehemently asserted that it is highly optimistic about the country’s future growth. While expectations from Budgets are always galore, because of the fiscal deficit situation, the Government has its hands tied and the hopes of so many goodies being rolled out may not be answered emphatically this year.

The timing of the vaccine rollout in India could not have been more opportune. As we all pray that the vaccine hopefully puts a curb on the virus spread, there is a likewise hope that the Budget proposals this year give a much-needed adrenaline shot to the economy and put it back on the high growth trajectory in sync with the Atmanirbhar Bharat vision and the ambition of India fast forwarding towards becoming a USD 5 trillion economy.

One can’t help but remember the renowned poet/novelist Victor Hugo’s quote recited by Dr Manmohan Singh in his landmark 1991 Budget Speech – “No power on Earth can stop an idea whose time has come.” This quote fits the bill perfectly and resonates very well with the ‘once in a 100 years Budget’ hinted by the FM.

As they say, “Extraordinary times warrant extraordinary measures”. With the faith that the Indian economy is poised to fly to greater heights, it would not be an understatement to say that 01 February 2021 is firmly circled on everyone's calendar - the outcome eagerly anticipated!!

Disclaimer - Views expressed are personal

Budget Wishlist of NBFC Sector - Much Needed Tax parity with Banks

The NBFC (Non-Banking Financial Companies) sector in India has undergone a significant transformation over the past decade and has created its own niche particularly in supplying credit to retail customers in the relatively under-served and un-banked areas and are playing a key role to meet the Government’s objective of financial inclusion and financial reach.

NBFCs are playing a significant role in Hon’ble Prime Minister’s quest for developing a New India by 2022 with greater focus on lower strata of society, promoting farmers’ prosperity, greater use of technology to bring transparency and on promoting entrepreneurship. They bring new borrowers within the ambit of formal finance by developing unique underwriting standards and inculcating financial discipline. Retail customers, MSMEs and SMEs have been the key focus segments for NBFCs spread across financial products like consumer durable finance, gold loans, equipment financing, hire‑purchase and leasing. This in turn fuels demand resulting in economic growth in the country.

From being around twelve per cent of the balance sheet size of banks (2010), they are now more than a quarter of the size of banks. In the last five years alone, the size of the balance sheet of NBFCs (including HFCs) has more than doubled from ₹20.72 lakh crore (2015) to ₹49.22 lakh crore (2020).

It is imperative to note that NBFCs are also subject to regulatory norms in all the key areas similar to banks, including requirement of minimum capital adequacy ratio of as high as 15 percent (9 percent for banks under Basel III norms), maintenance of leverage ratio and compliance with Know Your Customer norms, provisions of Prevention of Money Laundering Act, 2002 and other prudential norms. The NBFC sector is already subject to closer scrutiny by the RBI.

Further, the Reserve Bank of India has issued a discussion paper on 22nd January 2021 suggesting an overhaul of regulations governing the NBFC sector. RBI also released the report of the Internal working group report in November, 2020 on corporate structure for Indian private sector banks and the working group recommended that well-run large NBFCs with an asset size of Rs 50,000 crore and above may be considered for conversion into banks, subject to 10 years of operations and due diligence criterion.

The above recent developments clearly indicate intention of the RBI to move the regulation of NBFCs at par with Banks. It clearly signals the focus of RBI to regulate systematically important NBFCs and ensure a striking balance between financial stability and flexibility for innovation.

In the above backdrop of significant role played by the NBFC sector and constantly enhanced regulatory supervision similar to the banks, it is equally critical that much awaited tax parity to the NBFC sector with Banks also be accorded. Some of tax related expectations in the upcoming Budget 2021are as under :-

TDS exemption on Interest income under Section 194A of the Income Tax Act, 1961:

Banks and certain financial institutions enjoy TDS exemption on interest income. However, However, interest payments to NBFCs are subject to a tax withholding and the borrowers of NBFC have to comply with TDS provisions on payment of interest to NBFC, thereby putting NBFCs in a disadvantageous position from an operational efficiency perspective of the borrower. Besides, merely because of volume of transactions, it causes an administrative burden to NBFCs as it has to reconcile withholding taxes which could at times also result in rejection of claim for credit of withholding taxes due to inappropriate reporting of such taxes by the borrower. Tax withholding causes additional stress on the liquidity position of NBFC as taxes are deducted on gross income of NBFC which is in general much higher than the corporate tax liability on net income.

In view of the above, it is strongly expected that NBFCs will be given the much-needed exemption from withholding tax on the interest income. This will improve the ease of compliance for thousands of borrowers and also improve the ease of doing business. This will have no adverse revenue impact to the Government as taxes will be paid by NBFCs in form of advance tax. It will improve tax collection efficiency as in the present post pandemic situation, due to cash flow constraints, several borrowers in stressed sectors may be finding difficult to deposit the withholding taxes on time.

Deduction of Provision for Bad and doubtful debts under Section 36(1)(viia) of the IT Act: Section 36(1)(viia) of the IT Act provides that a bank shall be allowed a deduction of provision of bad and doubtful debts to the extent of 8.5 percent of the total income (computed before making any deduction under this section and Chapter VIA) and 10 percent of aggregate average advances made by rural branches of such bank. Whereas, such deduction is restricted only to 5% of total income for NBFCs.

It is to be noted NBFCs are making active contribution to the Indian Government’s objective of financial inclusion by providing financial access to the un-banked population in rural areas.  Hence, NBFCs having its branches and service centers in rural areas and lending to the rural sector in the form of agricultural loans, equipment finance, should also be equated to lending by rural branches of banks. Considering the role played by NBFC for rural financing, NBFCs should also be brought at par for similar deduction available to Banks.

Further in view of present liquidity situation and expected higher non-performing assets in the Banking and Financial Sector primarily due to economic challenges arising out of ongoing pandemic situation a one-time accelerated deduction of 15% of total income should on account of provisions for bad and doubtful debt

Suitable clarification on issues arising due to implementation of IND-AS: Effective 1st April, 2018, NBFCs have migrated to new Indian Accounting Standard, (Ind-AS) and as a result there a certain difference as compared to IGAAP which if followed by other financial sector players. For example, the method of computation of provision for bad & doubtful debts is governed by the Expected Credit Loss (ECL method) methodology as Stage 1, Stage 2 & Stage 3 loans whereas under IGAAP classifies loan assets in to – standard, sub-standard, doubtful and loss assets – and creates provision for NPA thereon accordingly.

Further NBFC need to accrue income on Stage 3 Loans (equivalent to NPA for Banks). Whilst Section 43D amendment in 2019 to bring at par certain NBFC with Banks is a step in right direction, a suitable clarification that such income recognized by NBFC is to be taxed only on actual receipt basis will avoid future litigations.

Certain other expectations include exclusion from applicability of provisions of section 269ST particularly for agricultural loan repayments etc. and thin capitalization rules similar to Banks and other financial institutions. applicability of TCS to Banks / NBFCs given that they are regulated entities and all transactions undertaken by them are duly accounted which is in lines with the objective of TCS.

With the significantly important role played by the NBFC under the strong supervisory control of RBI, Income Tax Department should urgently provide a level playing field to NBFC as discussed above which will support them to survive and provide credit impetus amidst the ongoing challenging economic situation due to after effects of pandemic.

Budget 2021 – Accelerating the Growth Momentum for PE/ VC Industry

This article has been co-authored by Hiten Ved [Counsel (Tax)], Begur & Partners.

India has always been preferred destination for Private Equity and Venture Capital (PE/VC) investors across the globe. Despite the pandemic induced blues, PE/VC investments in 2020 showed an upward growth trend of 6.6%. PE/VC investments are major drivers of the India’s growth story and hence, the following asks from the PE/VC investors from the forthcoming Union Budget 2021 needs a close attention.

• Further relaxations in Safe Harbour conditions:

The onerous conditions under Section 9A of the Income Tax Act, 1961 (“IT Act”) are acting as deterrent for the fund managers to establish presence in India. Further relaxation in these conditions could boost the fund management activities of offshore fund being undertaken from India. Certain additional relaxations for fund managers operating from the International Financial Services Centre (IFSC) are also on the wish list of the PE/VC industry.

• Tax parity for investment in listed and unlisted securities:

Given that a significant portion of the PE/VC funding also flows through investment in unlisted securities, reducing tax rates on capital gains from all unlisted securities to 10%, thus bringing it at par with the capital gains earned from listed securities would give further momentum to the investments from PE/VC investors. Having a uniform period of holding for both listed as well as unlisted securities to qualify as long-term capital asset will also address the said concern of disparity in taxability.

• Channelize debt funding for AIFs:

Interest on overseas borrowings by Infrastructure Debt Funds is taxable under the IT Act at a concessional rate of 5%. Similar concessional rate should also be extended to the funds raised from overseas investors by debt AIFs investing in certain select sectors to give an impetus to such AIFs to channelize more funds from the overseas investors. From investors perspective, concessional tax under the domestic laws would do away with the need to resort to tax treaty for taxability of interest income.

• Investment in AIF set up in IFSC (‘IFSC AIF’) by resident investors:

Investment by resident investors in IFSC AIF currently needs RBI approval. Given that setting up operations in IFSC is governed by separate regulatory regime, exemption should be accorded from the requirement of obtaining prior RBI approval for investment by resident investors in IFSC AIFs.

• Tax holiday to Category I and Category II AIFs set up in IFSC:

The tax holiday for IFSC AIFs is available for income earned from business activities. Given that Category I and II AIFs predominantly characterise their income as non-business income, they are not able to reap the benefit of the tax holiday. Appropriate amendment should be made to also extend the tax holiday to income which is not in the nature of a business income.

• Incentives for start-ups:

While government has already undertaken several measures to address concerns of the start-ups, further relaxation/ incentives for start-ups like expanding the turnover threshold to qualify as start-up, guidelines for overseas listing to enable start-ups to tap more capital, relaxation in withholding tax provisions to ease liquidity crunch, relaxation in angel tax provisions and measures to promote concessional lending to the start-ups would go a long way to boost the agenda of ease of doing business for the home grown start-ups and generate benefits for economy at macro level (by generating employment, increasing capital infusion, promote make in India, etc.).

• Waiver of long-term capital gain tax:

The wheel of investment have come to a halt due to the disruption in economic activities caused by COVID-19 pandemic. Therefore, the government should consider granting waiver of long-term capital gain tax on investments for the certain specified period. Providing waiver from long-term capital gains on investment would incentivising and encourage the investment by PE/VC industry in the dormant market and restart the fortune of investment in India.

• FDI in insurance:

Since insurance is a very important social security tool and given the increased importance of insurance in this global pandemic, the government should consider liberalizing the regime by raising the FDI sectoral cap from 49% to 74%.

• Extending the pass-through status to Category III AIFs:

The pass-through basis of taxation is currently restricted to Category I and Category II AIFs. The government should consider fulfilling the long pending ask of the industry to accord pass-through status to Category III AIFs.

• Extending capital gains exemptions on merger/ restructuring to LLP:

In order to bring LLPs at par with company, merger/ restructuring of LLP may also be brought within ambit of exempt transfers prescribed under Section 47 of the IT Act.

In consonance with its previous attempts, it is expected that the Union Budget 2021 will address the concerns of the PE/VC investors and promote India as one of the most lucrative investment destinations across the globe. This would also go a long way in achieving the government’s vision of breaking into top 50 countries in the global Ease of Doing Business rankings.

Budget Expectations Amidst Global Pandemic

Current state of economy: 

COVID was an unprecedented, once a century event and caught the whole world unprepared. Its adverse effect on the economy was devastating and resulted in: 

• Prompt announcement of lock down in India and resultant closures of virtually all business except essential items, which got prolonged, as in the absence of any treatment, COVID-19 spread faster than expected.
• Closures caused immense sufferings to small businesses, poor people, and lower and middle class. COVID-19 treatment costs further compounded miseries and around 1.50 lacs had lost lives.
• Millions of jobs were lost, or companies choose to cut pay of employees. Business establishments were closed, including hotels, rail, buses, transportation, and air travel.
• Closures rendered over 30 million jobless and unemployment levels as per latest CMIE data was over 9%, though employments levels are gradually improving, as businesses return to normal and migrants are increasingly moving back to cities.
• Working from home has become a new normal to protect life and contain spread of COVID-19.

Adverse economic indicators:

• GDP growth slowed down to historic low of -25 % plus in Q1.
• Fiscal deficit for the year is expected to rise to 6.5% to 7% as against estimated 4.5% due to slow down in economy and consequent sharp drop in tax collections. Shortfall in direct tax collections as as high as Rs. 7,00,000 crores.
• All key sectors of the economy shrunk to lowest level as indicated by lowest level of PMI, core sector and service index growth.
• Only sectors which acted as saviour were telecom, e-commerce, food delivery, online payments apps, digital banking, and ever reliable neighbourhood grocery stores. We could buy essential items and conduct normal banking and investment activities while working from home and being confined at home.
• Unemployment rate is still increasing, and ranged between 9.5% to % 5.92% in December 2020, which is worrisome.
• As a whole economy was crippled, and lot of households lost sources of livelihoods and had no other option but to use savings or sell assets to meet household expenses.

How government responded to contain the impact on economy?

• Stimulus of around 2 to 2.5% of GDP was provided to revive the economy which was on oxygen. Most of heavy lifting was done by RBI.
• Stimulus was largely in the form of liquidity infusion in the economy to ease liquidity issues, reduced interest rates, moratorium on loans, credit guarantee schemes for borrowings by worst affected sectors such as MSME, small business, stressed NBFC, cash subsidy to needy through direct transfers, food provisions, easy loan availability, record increase in allocation to MNRGA to poor for daily work etc.
• As per the IMF, governments across the world pumped in roughly $ 11.7 trillion as stimulus and central banks pumped over $7.5 trillion to preserve lives, livelihoods, and order in the financial markets. In India, the government and RBI through credit, liquidity, and relief packages cumulatively unleashed over Rs 30 lakh crore. (as reported by Bloomberg)
   
• RBI bought record dollars from open market to keep rupee stable and increase confidence of stake holders in Indian currency. Unintended but unavoidable impact was high inflation, compounded by supply chain disruptions.
• Incentives to corporates in the form of part of PF and other statutory deposits on new hiring to give push to employment. 
• Due dates for various tax payments were deferred to ease liquidity stress.
• Government spending was fall of requirements and disappointing. Recovery could have been faster if government had increased spending.

Green shoots are visible now:

• Lock down was gradually relaxed as COVID-19 infections cases started declining and now most of businesses are open.
• These relaxations resulted in revival in business, increased consumer demand in key sectors such as consumers facing, auto, real estate, jewellery, electronics, steel, cement, power consumption etc.
• Consumers sentiments, which is barometer if confidence of consumer, rose to 56% plus as on January 25,2021. 
• GDP of Q4 is expected to be better than previous quarters and full year GDP may be either positive or near thereto. 
• Experts are expecting GDP growth of 7 to 10% in 2021-22.IMF has forecasted growth of 11.5% in 2020-21, followed by 6.5%in 2022.However, IMF estimates that normal growth will only return by 2025.
• Higher than expected Q3 results of listed companies point towards economic rebound happening faster than expected.
• Balance of payments is expected to be at record low. Current account was in surplus in last few months.
• Indian foreign exchange at 586 Billion USD is at highest ever level and increase by 110 Billion USD during the year due to high levels of FDIs, FPIs investments, lower imports, Upward revision in value of gold reserve, increase remittances from NRIs etc.
• FDI flows into India rose 13% in 2020, the highest among top recipients of FDI in 2019.
• As interest rates plunged, money sought better returns in the United States and emerging markets. In December, foreign portfolio investors poured over Rs 62,000 crore into Indian stocks. The consensus opinion across markets is that the rising tide of public money lifted stocks and indices to record levels. (as per Bloomberg news report)
• Tax collections are increasing faster than expected, with GST collections achieving level of more than Rs 1,00,000 crores in last consecutive four months. 
• Due to record monsoon, farms production has far exceeded targets resulting in higher demand from rural areas, which is leading growth in all key sectors. Grains stocks are at record high, which is expected to ease inflation coupled with supply chains restorations and restart of normal manufacturing activities.
• All key economic parameters such as PMI, Service sector index, power generation, growth in freight movements (loading volume is up by 8.55 compared to last year, e-bills generations, increase in exports, imports grew by 7.5% in December etc are indicating revival of economy to pre- COVID-19 levels.

Expectations from the budget

In the background of current state of economy, which is struggling from impact of COVID-19, my expectations from the budget are as under:

Direct taxes:

• Last year, FM provided an option to pay corporate taxes at a reduced rate of 25%, provided certain deductions are not claimed. This step was taken with the twin objectives of:
• Making India a tax efficient country, with tax rates lower or equal to peer countries and make India an attractive investment destination.
• Utilisation of taxes so saved to invest in expansion and growth to accelerate economy which was slowing after years of good growth.
• This option was not given to other forms of business entities, such as proprietorships, partnerships firms, LLP, AOPs, HUF etc. Covid-19 had severally impacted business of these entities. It is fair to remove this inequity in tax rates and option of reduced taxes should be extended should be extended to all assesses, irrespective of form of legal entity.

Increase in tax exemptions and deductions limits:

• Budgets of last years had increased from time various deductions and exemptions available to individual assesses and salaried classes such as basic exemptions limits, deductions under various 80 G sections (80CCA, Mediclaim, housing loan repayments et.) and allowances such as leave travel concessions, HRA, Interest on repayment of housing loans etc. Increase of limits has, however not kept pace with inflation rates during the intervening period. It is only fair and equitable that amounts of such exemptions and deductions are increased in line with inflation rates. I would go one step further and request FM that appropriate provisions should be made in the Act to provide for automatic increase of such limits in line with inflation rates.
• I conducted a LinkedIn poll survey on this matter.83% of participants voted against this proposition.

Super Rich taxes:

• An Oxfam Report ‘The Inequality Virus’ states “India’s 100 billionaires have seen their fortunes increase by Rs 12, 97,822 crores since March 2020.” Gap between rich and common man has widened, as never before.
   
• The Bloomberg Billionaires Index, the combined wealth of the 500 wealthiest persons grew by over a third, surging by over $1.8 trillion to touch $7.6 trillion. Five individuals are in the $100 billion bracket, and 20 more are worth over $50 billion. Hence, there is a strong case for a one-time wealth tax or Robinhood tax on wealth of riches or it may be levied on increase in wealth during COVID-19 period.
• Countries around the globe including USA are seriously contemplating Super rich tax in one form or other. There are suggestions from some quarters that a one-time tax may be levied on high-net-worth individuals unrealised gains on investments during the COVID-19 period.
• In my view this idea may not be implementable in India at least, as it would require tax payments out of unearned income, the amount may be large, and it may be difficult for rich also to raise funds and that too at higher interest to pay taxes. Promoters may even have to pledge shares to pay taxes. Further such taxes gores against basic principles of taxation namely, pay as you earn and is likely to be challenged in courts,

Increase in Long term capital gains tax rates or STT rates:

Another option, which may be considered is to increase LTGC (say 5%) STT rates, which may be one time to raise resources to reduce fiscal deficits.

India low base-continues to be a matter of concern.

• Only 1.46 crore individual taxpayers filed returns declaring income above Rs 5 lakh in the financial year 2018-19 till February 2020, representing 1% of the population.

• Only 5.78 crore income tax returns were filed by individual taxpayers for the financial year 2018-19. Tax evasion is at the core of the low tax base in the country.
• The belief that India has very few taxpayers and millions of people routinely hide their income has been the underpinning for the country’s onerous income tax administration and a consequent mistrust of citizens. The income tax department has a Tom and Jerry relationship with taxpayers, indulging in an incessant chase of people under the conviction that nearly every Indian has large amounts of income stashed away in a secret corner. (Source: HT)
• I conducted a LinkedIn poll survey on this matter.78%% of participants voted against this proposition.

Reasons for low tax base:

• Low culture of tax compliance and payments; most of individual taxpayers are from salaried class, where tax compliances are higher due to tax deductions at source by employers.
• Rate of detection of tax defaulters is low, despite increasing vigilance, digital analytics, search and raids, corelation /reconciliation with digital data of GST data base etc.
• Hence, fear of detection is low, encouraging non-compliance culture.
• Lage part of business (around 88%) is contributed by informal sectors, where in many cases even invoices for goods sold or services are not generated.
  • The most effective way to increase tax collections is effective ground survey by IT staff. Sit in office assessments has its limitations in detection of tax evasion.
  • Tax evasion/frauds are particularly rampant in diamond, gold, silver, steel, cement, textiles, commodities, export, imports. business.
  • Agriculture income, which represents 15% of GDP is out of tax net, as government had no courage to tax agriculture income. Tax levy at fixed rate per hectare of large land holding of rich farmers needs to bring under tax nets. However, government may find it politically inconvenient in this budget due to ongoing farmers agitation. Under the circumstances, government may consider announcing a road map to gradually tax agriculture income on the said basis.
• Fear of tax harassment continues to scare taxpayers. Due to past track records of tax department. Government has promised various steps such as transparent taxation, tax friendly regime, face less assessments, online tax filings, including appeals against orders of lower authorities etc. But the problem persists.\
• To put this in perspective, the average American (earning America’s per capita income) pays a 22% income tax, the average Chinese pays 10%, the average Mexican pays 15%, and the average German pays 14%. Most nations in the world have an income tax threshold that is lower than their per capita income. India is a complete outlier in this aspect. (Source)
• Tax filers are significantly less than PAN allotted.
• As per data released by CBDT, only around 1.46 crore individual taxpayers are liable to pay taxes. Further, around 1 crore individuals disclosed income between Rs. 5-10 lakh and only 46 lakh individual taxpayers have disclosed income above Rs. 10 lakhs. These numbers are hard tom to believe and match with other data points, like number of cars, houses, sale of luxury items including jewellery, gold, smart phones etc.

Levy of Covid-19 cess:

• There are suggestions from certain quarters to impose COVID-19 cess to recoup part of cost/stimulus and vaccinations. Having regard to unprecedented damage caused by Covid-19, there is strong case to levy COVID-19 Cess.
• In the past as well government had levied cess to meet cost of natural disasters and for education. But government has dubious record of levying various types of cesses even contingency is no longer there. These cesses are same times not even used for purposes for which levied. There is no transparency/disclosures a to hoe these cesses were utilised.
• Cess is not required to be shared with states and hence, government prefers to raise resourced by way of cess.

• I conducted a LinkedIn poll survey on this matter.68%of participants voted against this proposition.

Is India a tax adversarial regime?

We may or may not like, but the whole world thinks so!

• UPA government made retrospective amendments, to undo decision of courts on Vodafone tax matters, which was perhaps was the biggest ever mistake in the history of Indian taxation. So much so that India earned dubious reputation of a tax terror regime. Global investors were scared to invest in India despite attractive opportunities due to growth potential of India.
• Modi Government came to power in 2014 with promises of big bang reforms, including ending tax terror regime, which in retrospect was a costly error. Even after 6 years of governance, government had not mustered the courage to undo the said retrospective amendments.
• Both Vodafone and Cairn Inc. Matters continues to cast shadow on India image as tax unfriendly regime, Recently, India lost both case in international tax arbitral awards. India could have utilised this opportunity to undo the effect of the said amendments. Unfortunately, India has chosen to prefer appeal against Vodafone decision. India is contemplation to prefer an appeal against the said order before International court. The amount involved is $1.2 billion.
• “It would be truly unfortunate if this were the only path to resolution but in the absence of India  adhering to the ruling, the company may be left with no other choice as it has a fiduciary duty to act,”, a portfolio manager). After giving assurances that it would honour the verdict, not doing so makes New Delhi appear unpredictable and recalcitrant. “Cairn’s claim needs to be resolved, and nobody wants it resolved this way,” Majcher, a portfolio manager. ((as reported in BS)
• This also meant a case of lost opportunity at a time when global companies like Apple are looking to shift manufacturing from China to India. Global investors poured in a record amount of with 13% jump in FDI. On the other hand, other countries reported big declines in investment. Admittedly, a large chunk of such investments we went into Reliance Jio and Reliance Retail. raised equity. There is no need to complacent on the buoyancy, as this may not be repeated every year.
• Only way forward is to use the forthcoming budget is to undo retrospective amendment among other measures to make India a tax friendly nation and remove concerns of investors in this regard. FM may have to consider making a provision for the Cairn payment and to drop appeal against the Vodafone arbitration and not to challenge arbitration award in higher courts.

I will cover balance part if this article in Part 2

Maiden Digital Only Budget 2021 – New Incentives Required for the ‘New Normal’

This article has been co-authored by Sarthak Parnami (Associate).

The last one year of the ‘new normal’ has brought transformational changes to the way different businesses operate all over the world including India. We have seen mostly all industries resorting to cutting down on business costs pursuant to outbreak of the COVID-19 pandemic. While India has embarked on its road to recovery, expectations from all the market players are at an all-time high from the first-ever digital only Budget to be presented in the Parliament on 1 February 2021. At the same time the government is also dealing with growing fiscal deficit and needs higher tax collections to deal with the effects of the ongoing Pandemic. May be this is the year, where the government could focus on providing much needed certainty in tax law and fixing those anomalies that result in unintended tax collection and at the same time also increase the litigation cost for the government. Captured below are some of the measures that would address the pain points and could boost market and investor sentiment.

1. Taxing the digital economy: The Finance Act, 2020 expanded the scope of equalization levy (EL) to include e-commerce transactions within its ambit. The introduction of the new provisions was sudden and was not accompanied with the Memorandum explaining the legislative intent. The new provisions remain ridden with ambiguities with foreign taxpayers having to adopt their own interpretations and constant threat of tax litigation. For instance, definitions of the terms “digital or electronic facility” and “platform” should be provided in law in order to assess the applicability of EL with more clarity. Further, advertisement services between two non-residents are also subject to EL, where the target audience are using an Indian IP address. Again, tracking of IP addresses of all users in not a simple task and there are also concerns on how the government itself will monitor adherence to such provisions. It should be considered if some of the onerous conditions could be dropped and law made simpler, even more so, where the transaction is purely between foreign service provider and service recipient.
2. Taxing stranded individuals and related foreign entities: Presence of an individual in India can result in nexus for the Indian government to tax that individual’s income and, in some cases, also tax the income of the foreign entity that employs the individual or is managed by such individual. A foreign entity is taxable in India where it is said to have a permanent establishment (PE) in India or is said to have it place of effective management (POEM) in India, in other words is controlled out of India. Depending upon the role played by a particular individual, presence of such individual can result in PE and POEM in India and result in the foreign entity paying Indian taxes. Halted operations of flights due to the pandemic resulted in various individuals being stranded across the world. While several countries have provided clarifications that such forced stay in their domestic country would not result in adverse tax for the foreign entities, India is yet to provide any clarification for financial year 20-21.
3. Taxation of deferred consideration / earn-out in M&A deals: Deferred consideration / earn-outs in M&A are being used more than ever to bridge the gap on valuations of businesses, especially due to the uncertainty created by the pandemic. The current provisions seek to tax the seller of the business / shares in the year of transfer even where part of the consideration may be received in a later year and worse, may never be received. Some courts have shown sympathy towards the taxpayers who are being taxed on a promise of a gain in future that may or may not accrue. The situation gets compounded by the fact that there is no recourse for claiming refund of excess tax paid, where the taxpayer does not receive the deferred consideration in a later year, as time window for revising past returns is extremely narrow. Relief could be granted on both counts: (i) tax the seller only when gains actually accrue, and not in reference to the year of transfer, and (ii) allow the tax return to be revised without a time cap, in certain cases, so that the taxpayer can claim his rightful refund. Needless to say, such changes would only further boost the start-up India and Make in India initiatives and facilitate Indian M&A.
4. In-specie distributions and contributions: Presently there is no clarity on whether in-specie distribution of assets as dividends would also be subject to capital gains tax in addition to dividend tax. Separately, there are also judgments dealing with charge of capital gains tax when capital contribution is made in kind. Shareholders should be able to contribute and withdraw assets from companies without being taxed twice and the clarity should be brought in the law.
5. Deemed tax on sale and purchase of assets: Specific anti-avoidance provisions seek to levy deemed tax on the seller and the buyer where the transaction is carried out at a value lesser than the market value of the assets. Such provisions hurt genuine distressed transactions. Also, valuation issues create unnecessary issues for genuine transactions. While the anti-avoidance provisions are necessary, a genuine taxpayer should not be subject to deemed taxes. Therefore, relaxation should be provided for distressed M&A and intra-group transfers.

Clarity can also be brought in with respect to valuation date with respect to transfer of listed securities, in an off-market transaction; currently, the valuation date is the value of shares on date of transfer of shares. Executing an off-market trade can take days after an agreement between the parties and invariably the price on execution date of the trade would be different from the consideration agreed by the parties. Such variation in price is not under the control of the parties but can result in deemed tax.

6. Exemption to foreign shareholders in case of a foreign amalgamation: An express exemption was granted to transfer of shares of an Indian company as part of an offshore merger, subject to certain conditions, by Finance Act 2015. However, a corresponding change was not made in the IT Act to also grant an exemption at the shareholder level where the shares of the foreign merging entity were said deemed to be situated in India (substantial value test / Vodafone tax). The gap seems unintended and dilutes the efficacy of the exemption granted and will also result in  tax litigation. Accordingly, it would be best if the corresponding changes can be introduced to provide for complete exemption to the merging entity and participating shareholders.
7. Applicability of Tax Collected at Source (TCS) provisions on unlisted securities and off-market transactions of listed securities:  The previous Finance Act, introduced an obligation on the seller of “goods” to collect tax at source, at the rate of 0.1%, from the buyer, over and above the consideration. However, the provisions do not define “goods” and what gets covered in its ambit. Further, the CBDT issued a circular clarifying that sale of listed securities, carried out on recognized stock exchanges, was exempt from TCS obligation, thereby implying that securities are covered within the meaning of “goods”. This resulted in there being an obligation for the seller of shares in a M&A deal to also collect the tax at source, thereby only increasing the compliance burden and adding complexity. It does not appear that the section meant to levy TCS on sale of investments (i.e., share not held as stock in trade) but a clarification is desperately needed.

Budget Expectations from Indirect Taxation

The Union Budget for FY2021-22 is slated to be one of the most important and anticipated budgets, given the economic devastation that has been caused, in India, as well as internationally, by the COVID-19 pandemic and the resultant lockdowns and market disruptions. The Budget will be considered the main step forward taken by the Indian Government to bring the economy out from the projected slump considering the economic stimulus earlier provided by the Government has been relatively ineffectual and the general consensus is that of a long hard road to recovery. At the same time, the Government has tried to set a new direction to the economy with emphasis on creating opportunities for domestic business and industry, and an effort to move towards a more self-reliant economy. In this context, the importance of targeted Government spending and extension of ease of doing schemes to the market will go a long way to catalyse economic activity and also activate an intention necessary for the economy to modernize. Some of the key demands of the industry, advanced over the years, if met, could hold the key of signalling the Government’s intention of progressive revival.

Today many sectors bear the brunt of the non-eligibility of refund of Goods and Service tax (GST) in cases of inverted duty structure. This is incumbent when the tax rates on outward supplies are lower than the rates on inward supplies leading to perpetual accumulation of input tax credit and hence blockage of working capital of the sectoral industries. The issue is common across sectors such as textiles, railways, mobile phones, fertilisers and footwear leading to a cash flow crunch in these sectors. The case for this refund has been advanced many times and in these perilous days would be a big boost to the affected sectors as it would allow access to trapped funds and also lead to a greater ‘ease of doing business’ in India.

Health care in another sector which has become vital in the present time. The unavailability of input tax credits, primarily due to healthcare services being exempted under the GST regime, is a cause of major heartburn, as GST paid on procurements in the supply chain constantly elevates the cost of healthcare services. The Government should consider making healthcare services zero-rated in order for companies to claim credit of GST paid on the supply chain. This would consequently bring down the cost of the output health care services being provided to the country. Reduction in GST rates for clinical trials (from 18%) performed in India for foreign companies is also desirable, considering the developments in the pharmaceutical industry in recent times.

The inclusion of petroleum products under the ambit of GST is a demand that has been simmering since the introduction of the ‘óne nation- one tax’. The retail prices of petroleum today consists of more than 70 percent taxes. Since, the Government is keen on taking initiatives like clean energy, products such as LNG can be considered to be initially bought under the GST regime to set up a platform for full induction at a later stage.

The Project Linked Incentive (PLI) Schemes is one way in which the Government is trying to promote local manufacturing. It should be the primary endeavour of the Government to extend this scheme to as many sectors as possible and provide the incumbent with related benefits. One area of expansion can be to cover manufacture of LED smart television sets under the PLI schemes as the domestic manufacturing market has a good potential but also suffers from a considerable imposition of local tax. Further, the imposition of 5% Customs duty in 2020 on open-cell panels, which is a key raw material for manufacture, also drives up the cost of television manufacturing. The extension of PLI schemes, rationalization of GST on sale of local televisions and the removal of Customs duty on essential raw materials would give an essential boost to this sector in terms of domestic manufacturing.

The other areas under GST laws which the Government could look at rationalizing in the Union Budget are removing the levy of interest on input tax credit availed, in case of non-payment of consideration to the vendor within 180 days (which was also recommended by the GST council); changing the place of supply rules to proclaim the place of supply of service provided by Intermediaries as the location of recipient of service – to help the domestic IT/ITES/ Back Office Industry and be in tandem with international VAT practices; extending relaxation to receipt of foreign exchange for a further six months, from one year from date of export, for export of services, in view of the global supply chain disruptions in view of the pandemic; and make the payment of GST, on collection basis, for Micro, Small & Medium Enterprises (MSMEs), given the severe capital crunch being faced by the MSME(s).

The payment of GST on reverse charge for import of services should also be allowed by input credit, instead of cash, to alleviate the massive cash crunch being faced by the industry. The Government could also think of giving effect to recent developments bought out by judicial decisions- like removal of IGST on ocean freight, when provided by a person in the non-taxable territory which would bring a much debated issue to rest to the benefit of importers in India. Clarification on contentious issues like levy of GST on intra-office cross charge and inclusion of employee cost in the same would also be welcome.

In terms of procedural issues, the Government should rationalize the GSTN portal to allow amendments at the time when input tax credit is taken, take a re-look at some harsh notifications issued, particularly the amendment to Rule 21A of the CGST Rules, denying opportunity of hearing in case of perceived misdoing and cancellation of registration, and further, consider allowing the industry some leeway in introducing the e-invoicing and QR code implementation on invoicing, as they are presently limping out of an era of lockdown which has caused severe damage to available resources.

On the Customs front, facilitation measures should be considered to be introduced in all major Customs ports (in synchronicity with the Risk Management System and operational tweaks in the Faceless Customs Measures) for expedited clearance of all Exim goods, and particularly related to E-Commerce. This will give a much needed fillip to the industry as considerable ‘dwell time’ will be reduced. Other measures that are the need of the hour is the overhauling of the Special Valuation Branch (SVB) scheme to reduce the constant burden of backlog, and a move towards introducing competitive import tariffs over the course of the next three years, with lowest or nil slab on inputs or raw materials (say 0-2.5%), standard slab for final products (say 5.00-7.5%) and intermediates at an intermediary level (say 2.5-5%).

As always, the wish list for the first pandemic Budget is huge and cannot be covered in reams of paper. The overall objective of the Government should be the recovery of the economy and reassurance to the industry, and also an indication of faith, to show that they are in-step with the demands of the market and committed to the overall principle of ease-of-doing business. 

Exploring the hopes around Transfer Pricing in Budget 2021

Introduction:

2020 will be considered as one of the most challenging years in the last century. This demanding year emphasized the importance of physical health to the world that is engaged in digitizing and transforming life. The pandemic has also ravaged economies across the globe, plunging businesses into a state of despair.

In the last year, several businesses have been severely impacted due to numerous supply chain restrictions enforced due to social distancing. The MNEs that operate globally and have large dependency on the cross-border trade (including intra-group trade) are grappling to address the near-term sustainability of their businesses. The businesses are re-visiting their operational model in line with the market scenario.

The government has already released multiple economic stimulus packages as a part of Atmanirbhar Bharat Abhiyan to revive the economy. The package includes collateral free loans to MSMEs, liquidity scheme for NBFCs, extension of tax due dates, employment schemes to boost opportunities, etc. The stimulus package was aimed to reduce the burden on businesses by infusing funds and relaxing the compliance burden to help them concentrate on business. While these measures definitely eased the situation, the financial economy has not recovered, and therefore, taxpayers are expecting extraordinary measures from Hon’ble FM in this unprecedented situation.

Union budget 2021 is expected to be announced on 1^st Feb 2021 with the potential economic impact of the pandemic looming large in the year 2021, the taxpayers across industries have expectations from the government concerning tax reliefs and ease of compliance burden. This article explores the budget 2021 wishlist on the Transfer Pricing side.

1.        Safe Harbour Rules expected to be extra-safe

In May 2020, the CBDT specified the safe harbour rates applicable for only FY 2019-20. The erstwhile safe harbour rules (SHR), as well as prescribed rates, were kept unchanged. The taxpayers are anticipating that safe harbour rules for FY 2020-21 as well as subsequent period are notified soon. 

Over the years, the ministry has actively taken steps to reduce litigation and honouring the honest. In such a scenario, taxpayers expect SHR to be re-visited to bring down the rates in line with ongoing market conditions.

With respect to intra-group loans denominated in foreign currency, existing SHR provides a reference to LIBOR rates. With the looming end and demise of LIBOR after 2021, financial regulators around the world are seeking support to prepare for a transition. In light of this development, it is expected to update SHR with alternate base rates.

The ministry may also look to increase the benefit of SHR to an additional industry as well as intra-group transactions. Similar to availing of low-value added intra-group service, payment of royalty transaction may be covered for different industries. This shall help put an end to one of the most litigated issues under the Indian transfer pricing regime.  The government may also consider extending the SHR benefit to distribution arrangements.

Failure to prescribe attractive rates for a covered transaction may fail the SHR mechanism and taxpayer’s interest to opt for the scheme.   

2.        Relief measures towards the potential economic impact of the pandemic

In December 2020, the Organisation of Economic Co-Operation and Development had released the much-awaited guidance on COVID-19’s impact on Transfer Pricing. Countries like Singapore, New Zealand and Australia have also pro-actively published their guidance for taxpayers and relaxed certain regulations. It would be very important for tax administration in India to provide relevant guidelines which could be adopted by the taxpayers which doing the transfer pricing analysis in this pandemic hit period.

·          Transfer pricing methods and adjustments 

The most common concern for many MNEs as well as tax professionals is how to justify losses or significantly low profitability of the taxpayer.

Indian Transfer Pricing Regulation (ITPR) has prescribed six methods to compute the arm’s length price of a controlled transaction. In case there are deviations, it also requires making reliable economic adjustments to apply the most appropriate method. Given the magnitude of the pandemic, it is certain that a lot of adjustments would be required to be carried out in concluding a transfer pricing analysis. Key challenges which the Indian taxpayers are currently facing in the existing regime are – 

Indian transfer pricing regulations do not allow adjustments to be carried out on ‘tested party.’ On the other hand, it is an established fact that relevant data points required for making economic adjustments are not readily available for comparable companies in their annual report. This makes things very challenging to compute the economic adjustments. The Indian tax administration may consider a change in the law, which will allow adjustments to be carried out in the ‘tested party’ as well.

The concept of an overseas entity as a tested party has found a very low level of acceptability in the Indian jurisprudence. It is only recently that few courts in India have appreciated and accepted the use of an overseas entity as a tested party. However, the first level tax authority and first level appellate authorities have been rejecting this concept on the legal ground stating that the Indian transfer pricing regulations don’t allow the use of an overseas entity as a tested party. The Indian tax administration may consider a change in law, which will put an end to the controversy that an overseas entity can’t be selected as a tested party. 

While ITPR doesn’t provide enough guidance, many judicial precedents have allowed different adjustments to be carried out having regard to the facts of the case.

It is expected from ministry to release detailed guidelines on adequate economic adjustments that can be made to address capacity disruption, working capital positions, exchange fluctuations, extraordinary expenses (higher input costs, severance payments, interest payments on defaults, penalties, etc.), differences in inventory valuations, depreciation and various market-related issues in order to make appropriate proper comparability analysis from a Transfer Pricing perspective.

Additionally, there could be a widespread application of the Profit Split Method (PSM), which was erstwhile dredged by tax practitioners and not preferred in performing Transfer Pricing analysis. Considering the fact that many of the MNEs are restricting the operations, PSM could now emerge as one of the most popular methods in Transfer Pricing analysis. Therefore, it would be important for the Indian tax administration to come out with detailed guidance on the use of an array of assumptions, assigning weightage to entities basis the amount of contribution in their value chain, and the subsequent allocation of corresponding profit/ loss.

·          Use of single year vs multiple year data

Typically, taxpayers in India would prepare their transfer pricing documentation on a post-facto basis, whereby they evaluate the actual results achieved based on the single year financial performance against what comparable companies have earned in last 3 years (including current year).

This approach clearly needs reconsideration in this situation wherein practically financial data of the comparable companies for the current year end are not available at the time of undertaking comparability analysis before filing a tax return. Thus, taxpayers will end up evaluating their current year’s profitability wounded by the pandemic with results of comparable companies spanning years not impacted by COVID-19. It will not only be an inappropriate analysis but also be challenging for taxpayers to justify arm’s length price.

Especially the period between February 2020 to December 2020 was heavily impacted by nationwide lockdown, and it has resulted in drastic deterioration of business profitability; comparing the profitability of this period will paint a misguided picture while performing economic analysis.

Thus, some guidance on applying single year data against multiple year data is expected to demonstrate appropriate comparability analysis.

·          Advance Pricing Agreements (APAs)

While entering into an APA, tax authorities and taxpayers lay down critical assumptions that pave the way for negotiations undertaken during the course of the proceedings. Certain factors like force majeure, market disruption and change in functional analysis, revamp of Transfer Pricing policies could have a major impact on the transfer price agreed between the parties. In fact, breach of critical assumptions may entail invalidity of the agreed APA and thereby, significant efforts, time and money may go in vain for MNEs.

Many MNEs are eagerly waiting for guidance, providing an opportunity for proactive dialogues between the taxpayers and tax administration in order to pave the way for keeping APA alive. Relaxation measure may also include a one-time discount in agreed remuneration for the agreed period with regards to the nature of transaction and industry.

At the same time, ongoing APA where negotiations are still not finalized, it is expected from the tax administration to act reasonably fair and allow making changes in the proposed model or remuneration policy

3.        Specific guidance on Faceless Assessment Scheme for Transfer Pricing audits

While the government has already notified the Faceless Assessment Scheme to provide greater transparency, efficiency and accountability in tax assessments, the government's objective is to effectively use modern-era technology to maximize efficiency and adopt a team-based approach while making the assessments.

The faceless scheme has eliminated human intervention between taxpayers and tax officers. Therefore, taxpayers need to explain/communicate by way of a written submission to make them understand the fact pattern without any ambiguity.

As we know, Transfer Pricing is mainly a fact-specific exercise, and therefore, it is imperative to explain the fact pattern involving complex business model/intra-group transactions. While taxpayers do need to present the facts in written mode, oral representation would help avoid ambiguity. Faceless assessment (without a personal hearing) may increase miscommunication/misunderstanding for taxpayers and tax authorities. On one side, large MNEs feel the threat to submit commercially sensitive information online owing to confidentiality issue, small/medium taxpayers (especially in non-metro cities) may struggle with adapting to the new system/approach, especially in explaining complex transfer pricing issues.

In lieu of the above, we expect the ministry to simplify the procedures for Transfer Pricing cases so that the taxpayer gets a reasonable opportunity of being heard by tax authorities.

4.        Other expectations

·          Joint audit for multiple years – At present, the Indian tax administration follows a single year audit process, involving significant time and efforts each year for repetitive issue. Like few developed countries (such as the USA), it is expected to roll out a process for joint audit process wherein multiple years (2-3) may be scrutinized at one go, especially where issues/covered transactions involved are similar. This move will significantly save time, cost and efforts for taxpayers as well as tax administration, and it would be a milestone change in the Indian litigation arena.

·          Guidance on financial transactions – In early 2020, the OECD has issued guidelines on financial transactions providing in-depth analysis and covering specific issues relating to pricing of loans, guarantees, cash pooling, etc., to bring consistency in the application of transfer pricing policies. The Indian tax administration may consider issuing it’s intention to follow the said guidelines for determining the arm’s length price for intra-group financing transactions.

While a well-known quote encourages “Lower expectations, and you will lower your disappointments in life,” however, this unprecedented time has raised the bar of expectations from the finance ministry, which will hopefully launch a plan that will put taxpayers’ minds at ease.  

The expectations continue… Transfer Pricing and 2021 Union Budget!

This article has been co-authored by Meenu Wadhawan (Associate Director), Nangia & Co LLP

(With inputs from Anirudh Gupta)

It’s Budget time again but the sentiments are very different this year. The budget time coincides with the roll out of vaccine and the expectation would be similar from the upcoming India’s Union Budget 2021, to relieve the economy from the effects of the pandemic. The wishlist is not just expecting the government to introduce measures to accelerate the road to economic recovery but also to increase India’s Global ranking index in ease of doing business to attract as well as retain capital investments in the country. As always, the bucket list is a bottomless pit but the task this year should be cut out for the Government. The focus should clearly be on immediate tasks, i.e. savings, investments, instill confidence and lead from the front. If the Indian cricket team could win with a depleted attack, then why cannot India as a nation against the pandemic.

In this article, we would like to focus on the recommendations from the transfer pricing (TP) perspective, including both at policy level as well as to ease out practical challenges faced by the taxpayers, most importantly to provide immediate relief due to the pandemic related economic disruption. Some of these recommendations would further help align the Indian TP regulations with the global best practices.

Recommendations to ease out TP related practical challenges faced by the taxpayers:

·        Use of Multiple years’ vs Single year’s data

Given the latest year’s margins i.e. for FY 2020-21 for most of the comparables’ would not be available at the time of undertaking TP compliances, thus the taxpayers would be forced to rely on the pre-pandemic era margins of comparables. Therefore, in order to even out such practical difficulty, it is recommended to follow comparison of either latest three-year weighted average margins earned by the taxpayer with a similar three-year weighted average margins available in case of comparables’ or single year’s data to be considered in case of both the taxpayer as well as the comparables.

·        Use of Range Concept – 25-75th percentile to be adopted instead of 35-65th percentile

Currently, under the range concept provided in Rule 10CA of the Income Tax Rules, 1962 (the Rules) for determination of arm’s length price (ALP), Central Board of Direct Taxes (CBDT) had notified use of 35^th to 65^th percentile in case of 6 or more comparables, else use of arithmetic mean (AM) in case of less than 6 comparables. However, considering the global best practices followed by most of the economies (i.e. use of inter-quartile range), it poses real practical challenge to justify different range used in different jurisdictions. Based on such global experience and to check alignment with the world, the interquartile range (i.e. 25^th - 75^th percentile) should be considered under the range concept, in order to use the better representative of the sample population of the comparables considered.

·        Arithmetic mean – end of long road

In India, the concept of AM was introduced with the enactment of the TP provisions in the Income Tax Act, 1961 (the Act). Although, the said statistical tool has been in place for almost two decades now, it is not the best representative of the industry margins. This is because the said statistical tool is not the best measure of central tendency and shows distorted results which are easily influenced by extreme values or with more dispersed (volatile) data sets. If AM is to be continued, then it may be worthwhile to restore the +/-5% tolerance band than using the +/-3% or +/-1%.

·        Section 94B of the Act - Limitation on interest deduction

Considering major economies are going through recession/ slowdown due to the pandemic, many entities including the ones with low capital base are facing the liquidity crunch. Given the downgraded credit rating of such entities, it becomes tough to borrow from the financial institutions; thus, the businesses to keep themselves afloat would avail funds either through intragroup financing or through guarantee provided by the overseas parent entity. To ensure no hardships due to the pandemic, it may be worthwhile to contemplate enhancing the applicability limit of Section 94B of the Act from existing INR 1 crore to provide adequate relief to the taxpayers in the admission of deductible interest expense on such intra-group loan availed and keep the loan backed by guarantee (both implicit and explicit) outside the purview of Section 94B of the Act.

·        Section 92CE of the Act - Secondary adjustment

The secondary adjustment provisions were introduced vide Finance Act, 2017 implying adjustment in the books of account of the taxpayer and it's AE to reflect the actual allocation of profits between the taxpayer and its AE in line with the ALP, determined as a result of the primary adjustment(s) exceeding INR 1 crores. Considering the current pandemic situation, the authorities should contemplate for upward revision of the said existing threshold of INR 1 crore provided in Section 92CE of the Act.

Further, even though CBDT issued notification dated 30 September 2019 clarifying the period for cash repatriation post Advance Pricing Agreement (APA) and Mutual Agreement Procedure (MAP) conclusion, however, it is recommended that the secondary adjustment provisions should not be applicable in the first place on the dispute resolution programs, i.e. APA, MAP and Safe Harbour. If the settlement has already been provided by the Department, then there should be no further grievance or demands on their part atleast.  

·        Due date of filing of Accountant Report (AR) in Form 3CEB

The due date of filing of the AR should be made along with the Income Tax Return (ITR) instead of the recent change of filing it one month prior to the ITR, so that the positions to be adopted in case of both the AR and ITR could be considered in tandem. Both the compliances are inter-related, especially for Foreign Entity (including Permanent Establishment) compliances. 

Recommendations for the policy-level change concerning Indian TP legislation:

These are policy level changes that may not find their way immediately in this Budget considering the circumstances, but could be considered as these form part of Government’s larger vision of non-adversarial tax regime.

·        One-time Settlement/ Amnesty scheme for past years

For the TP cases, say wherein a MAP application could not be filed in the past years since India’s position on acceptance of MAP cases in absence of Article 9(2) [correlative adjustment] in Double Tax Avoidance Agreements (DTAA) with countries such as Germany, South Korea, Singapore, etc. got clarified by CBDT in November 2017, a one-time settlement scheme could be announced for such Taxpayers. Herein, CBDT could seek to settle the cases with reduced payment of taxes, unlike the amnesty under Vivad Se Vishwas Scheme wherein the taxpayer needs to pay complete demand and there is no discussion on the merits of the case.

·        Dispute resolution mechanisms such as Safe Harbor Rules (SHR), APA, MAP, Dispute Resolution Panel (DRP), and Commissioner Income Tax (Appeals) (CIT-A) should be made more attractive

The CBDT could consider commissioning of Settlement Commission or equivalent specifically to address TP disputes or enhance the powers of DRP/ CIT(A) to waive penalties and settle disputes with appropriate approvals from CBDT.

At the CIT(A) level, there are two main grievances to be addressed – payment of demand of atleast 20% and no time limit for passing of order by CIT(A). Addressing the two could inflict much confidence in the sentiments of the industry.

As regards to the SHR, it could become a safe bet for future. However, it suffers from some deficiencies - the rates in the provision are not closer to the ground reality, has limited applicability and are announced post the end of the year. As a wish list and specially in the pandemic year, more rationalised rates only for FY 2020-21 could be well appreciated by the industry (rates were recently announced only for FY 2019-20, and hence there is precedence). It would be small price to pay in exchange for a predictable and definite solution, which would also curb litigation and use less of Government machinery.  Also, it would be prudent to announce safe harbour rates along with the finance budget itself instead of announcing through a circular/ notification after the end of the year. This would help the industry to analyse it in detail and timely decide to opt for it. If the advance tax is required to be paid on the estimated income, then please help the industry in estimating their income by announcing the SHR at the beginning of the year.

The Indian APA program and MAP settlement has been very successful. The recent amendments in the MAP rules also suggest the shift to consider resolutions outside the Courts. With such a thought process, these programs should be given considerable impetus as they have the capability to find efficient solutions to complex business models/ transactions.

·        Block assessment to be considered

In line with the global best practices followed by many developed countries such as US, Germany, Australia, and many other European countries (as we witness in their specific jurisdictional TP case laws as well), it is suggested that block assessment of 3-5 years should be considered for TP issues such as royalty payments, management cross-charges, etc., as the issues involved are mostly cyclical in nature and carrying out a separate assessment for each and every year results in wastage of valuable resources of the taxpayer as well as the tax department. Though, in certain cases this may conflict with the circular restricting the TP cases to risk-based assessment from value-based assessment, suitable amendments may be required there too.

·        Section 92E of the Act – AR in Form 3CEB

Presently, the compliance of filing of an AR in Form 3CEB is akin to an intimation, wherein the taxpayer discloses information relating to the international transaction(s) undertaken during the year along with the method it finds most appropriate to benchmark the said transaction(s). Even though the said AR is duly signed by an independent Chartered Accountant (CA), the onus for justifying the information provided therein is still on the taxpayer. The authentication by the CA renders no value addition in the existing form, as it has no practical relevance later once the TP documentation is submitted by the Taxpayer. Therefore, it may be prudent to either, incorporate the required field in the tax return itself to ease compliance burden, or Form 3CEB is self-attested by the Company similar to ITR, as well as Master File (MF) and Country-by-Country Report compliances.

In addition to the above, it is suggested that the Government of India should clear the ambiguity surrounding the issue around undertaking TP compliances by a foreign company, where there is no requirement to file any ITR.

·        Associated enterprise under Section 92A of the Act

According to Section 92A(2)(c) of the Act, two enterprises shall be deemed to be AEs if, at any time during the previous year a loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one percent of the book value of the total assets of the other enterprise.

Under the above provisions, an exception needs to be carved out for loans advanced by banks/ Non-Banking Financial Corporations (NBFCs) since such enterprises are into the business of lending funds and this creates undue issues/ challenges for small and medium enterprises not having sizable assets, particularly during COVID-19 times.

·        Revision of threshold limits for MF

The threshold limit for MF should be enhanced to almost double from the existing threshold of Consolidated Group Revenue greater than INR 500 crores, to reduce the compliance burden on small and medium enterprises in India.

Additionally, MF requirements should only be made applicable to constituent entities resident in India and should not be applicable for the non-resident or the foreign entities in order to reduce the unnecessary compliance burden on the non-resident entities. They would be undertaking such compliances in their respective jurisdictions, so the duplicative efforts should be avoided.

Concluding Thoughts

Although, the Indian government is making palpably extraordinary efforts to counter the downturn with fiscal and monetary policy support, there is still considerable time and effort required to overcome these unprecedented times. Despite the Union Budget 2021 being vexed for the government too, since the plate is already too full with policy matters such as, controlling the fiscal deficit, monetary liquidity, sustainable growth of the economy, etc. it would be worthwhile to see whether the above recommendations related to the TP Wishlist find their way in the upcoming budget .Atleast the recommendations to ease out TP related practical challenges faced by the taxpayers should find some mention in the final prints. Afterall, TP regulations are intimately connected to the economic growth of the country and influx of foreign direct investments or outbound investments. The Government should look to hit the hook and pull shots, instead of ducking on the bouncy pitches!

Budget 2021- Relief to Salaried Class and Employers for ‘Home Office’ Expenses

This article has been co-authored by Vedika Kedia (Chartered Accountant).

Background

The spread of the Covid-19 pandemic and subsequent nationwide lockdown caused disruption in business and changed the manner of conducting business by various large corporates. To ensure safety of their employees, most major corporates adopted the concept of ‘Work from Home’ (WFH) wherein the employees were able to perform their day- to-day activities from the safety of their homes with the help of various new age technological innovations. What started as just WFH has moved into a full-blown scenario with hybrid workforce. In a world that will be called ‘post-Covid-19 era’, we will see the re-shaping of business operations and consumer behaviour. Certain surveys have stated that WFH will be the new normal which companies will have to inevitably conform to. Many large corporates are looking at permanently shifting a percentage of their workforce to remote work locations which will have dual advantages of ensuring employee safety and cost savings for the company in form of infrastructure costs.

Though remote working or WFH had its set of advantages for both the employers and employees, it also led to additional cost being incurred by the employees for setting up of a office at home resulting into increase in consumer spending on various technological consumables such as mobile handsets, headphones, computer peripherals such as printers, desktop monitor, etc. Also, in order to set up dedicated work-stations at home for prolonged use, most employees also purchased work chairs, desks and reading tables. Most large corporates compensated their employees for this additional expenditure either by providing a lump sum allowance or by providing actual cost reimbursements.

Section 10(14)(i) of the Income-tax Act, 1961 (the Act) read with Rule 2BB of the Income-tax Rules, 1962 (the Rules) provides exemption on any special allowance granted to employees specifically to meet expenses wholly, necessarily and exclusively incurred in the performance of the duties of an office. However, this section does not cover perquisites within the meaning of section 17(2) of the Act. Therefore, it becomes necessary to analyse the taxability of reimbursement for expenditure incurred for WFH enablement or setting up of home office.

In above backdrop, we shall discuss the tax implications of certain expenditure incurred for setting up of home office in the hands of the employer and the employee and budget expectations from the Government in this regard.

1. Taxability of reimbursement for purchase of Mobile Phone

From employees’ point of view

As per section 17(2)(viii) of the Act, perquisite inter alia includes any amenity provided by the employer to employee. Rule 3(7)(vii) provides that 10% of value of benefit resulting from the use by an employee of any movable asset other than laptop and computer belonging to the employer shall be taxable as perquisite after reducing the amount recovered from employee.

Further, Rule 3(7)(ix) provides that the value of any other benefit or amenity shall be determined on the basis of cost to the employer under an arm’s length transaction as reduced by the employee’s contribution, if any. However, by way of proviso, expenses on telephones including a mobile phone incurred by employer on behalf of the employee have been kept outside the purview of rule 3(7)(ix). The extract of the proviso is as below:

“Provided that nothing contained in this clause shall apply to the expenses on telephones including a mobile phone actually incurred on behalf of the employee by the employer.”

On combined reading of section 17(2)(viii) and rule 3(7)(ix), it is possible to argue that reimbursement of expenses for purchase of mobile phone is covered by the exception provided under the aforesaid proviso. Hence. it should be excluded from being taxed as a perquisite in the hands of the employee.

However, a conservative reading of the proviso suggests that the words expressly used are “expenses on telephones including a mobile phone”. This could mean that the intent of the legislature by way of this proviso was to only exclude routine expenses (such as phone bills, repair and maintenance of the device, etc.) and not the cost of purchase of a mobile handset.

If this conservative view is considered, there could be two situations regarding the taxability of cost of mobile handset in the hands of the employees:

a) Mobile handset purchased in name of employer

Let us first consider a case where the handset is purchased by the employer and provided to the employee. What is excluded by Rule 3(7)(vii) is only “laptops and computers” and thus one cannot rule out the possibility of tax department arguing that in the absence of exclusion of mobile phones in Rule 3(7)(vii), 10% of the original cost of mobile phone should be considered as perquisite in the hands of the employee.

b) Mobile phone purchased in name of employee

Another situation could be where the mobile phone is purchased by the employee in his own name and a subsequent reimbursement is provided by the employer. In such a case, there may be an exposure under section 17(2)(iv) which provide for taxability of any sum paid by the employer in respect of any obligation which, but for such payment, would have been payable by the employee.

An alternative line of thought is that the valuation should be done only if there is any ‘benefit’ in the first place. This will be more so when an employee is required to work from home, it may be argued that mobile phone provided by the employer/ reimbursed by the employer should be seen nothing more than a tool to perform official duties. Thus, one view could be that the use of employer’s/ reimbursement by employer of the mobile phone by an employee should not result in any taxable perquisite.

Currently there are no judicial precedents to substantiate either views and to our knowledge, several organizations do a strict reading and not cover cost of mobile handset within the proviso to Rule 3(7)(ix).  Hence, it will be helpful if there is some clarity provided on this aspect within the Budget proposals.

From employer’s point of view

The employer may evaluate two options while doing the accounting treatment for reimbursement of mobile handset charges i.e. either expenses-off the entire amount in the year of incurrence or capitalize it in books. The following parameters may be noted when classifying a particular expenditure as capital in nature:

1. It should have an enduring benefit on the business;
2. It should be owned by the Company.

In case, the employees purchase the mobile phone in their own name, it would be difficult for the employer to satisfy above parameters. Therefore, it may not be possible for the employer to record the expense reimbursed on mobile phone as a capital expenditure. However, the employer may claim such expenditure as deduction under section 37 of the Act. In this regard, reference may be drawn to the decision of the Delhi High Court in the case of PCIT v. Nokia India (P.) Ltd[1] wherein the High Court had held that where the corporate had given phones to its employees, dealer etc. and, ownership had been transferred to employees, dealers, sales personnel and after-sales-service centres, with a pre-condition that the mobile phones were not to be returned to corporate, the cost of mobile phones was to be considered as a business expenditure.

2. Taxability of reimbursement for purchase of furniture (chair, table, etc)

From employees’ point of view

In case of reimbursement for purchase of furniture to employees by employers, generally, the furniture would be owned by the employees. Therefore, in such scenario, the reimbursement towards any of these assets would be construed as a perquisite under section 17(2)(iv) of the Act on account of ‘any sum paid by the employer in respect of any obligation which, but for such payment, would have been payable by the assessee’ and would be considered as fully taxable in the hands of the employees and subject to appropriate tax withholding under section 192 of the Act.

Alternatively, where the assets are treated as belonging to the employer, then the same would be considered as a benefit to employee from ‘use of moveable asset belonging to the employer’.  The value of the benefit or perquisite to the employee in this case would be determined as prescribed under clause (vii) of Rule 3(7). Accordingly, the perquisite value would be determined at 10% per annum of the actual cost of such asset (or the amount of rent or charge paid or payable by the employer), as reduced by any amount paid or recovered from the employee for such use.

Considering that the WFH culture is here to stay for the long haul, it is expected that some relief in form of exemption is provided to the salaried class for expenses reimbursed by the employer for purchase of home office furniture and fixtures.

From employer’s point of view

In case of pure reimbursement wherein employees purchase the furniture and are reimbursed for such expenditure, the employer may not capitalize such expenditure in its books considering the parameters mentioned in aforementioned paras. However, in this case, the employer would be able to claim deduction of such expenditure as business expenditure under section 37 of the Act.

In a different scenario where the furniture is purchased in the name of employer, the employer may capitalize them in its book and claim depreciation thereon as per the relevant provisions of the Act.

An express clarification on this aspect in the Budget proposals will be helpful to avoid diverse views.

3. Taxability of reimbursement for purchase of Printer, Desktop, Keyboard, or other computer peripherals

From employees’ point of view

In this case also, there may be two scenarios, one where the employees purchase these assets in their own name and get reimbursed later on, in such case, such reimbursement would be taxable as perquisite under section 17(2)(iv) of the Act and the employer would be liable for withholding as per 192 of the Act.

Alternatively, in case these assets are treated as belonging to the employer, then the same would be considered as a benefit to employee from ‘use of moveable asset belonging to the employer’ under sub clause (vii) of Rule 3 as discussed above.  However, clause (vii) of Rule 3(7), specifically excludes the use of Computers and Laptops provided by employer to employees from ambit of being considered as a taxable perquisite in employees’ hands.  However, sub-clause (vii) does not prescribe any guidance on whether computer peripherals like Printers, Desktop, wireless keyboard/ mouse, etc which are provided/ reimbursed by the employer would also be considered as ‘computer and laptops’ and therefore outside the purview of perquisite taxation under clause (vii) of Rule 3(7). 

Reference can be placed on certain judicial precedents[2] in the context of rate of depreciation applicable to computer peripherals, wherein it was held that the peripherals such as printers, scanners, etc. form integral part of the computer and the same, therefore, are eligible for depreciation at a higher rate as applicable to a computer. Relying on these rulings, a view can be taken that computer peripherals being an integral part of computers can also be excluded from being considered as perquisite as prescribed under clause (vii) of Rule 3(7). However, such a position may be litigative and can be challenged by the tax department which may compute 10% of the original cost of the asset as perquisite in the hands of the employee.

Hence, in order to avoid litigation, it will be beneficial if some clarification is provided in this regard within the Budget proposals.

From employer’s point of view

Our view in this case is similar to that in case of furniture and fixtures mentioned in the preceding paras.

Conclusion

As the concept of WFH is here to stay, it will be in the interest of the salaried class if some relief is provided for ‘home office’ expenses. Recently, Canada had announced deductions for ‘home office’ expenses for employees working from home during Covid-19 pandemic. Similarly, other developing and developed countries are taking initiative to provide exemption or deduction of WFH enablement expenditure.

Also, in order to encourage the concept of WFH, it is also recommended to provide clarity for deductibility of WFH expenditure / reimbursements in the hands of employer to avoid any litigation. Such proposal would reduce the overall tax burden in the hands of the employee and the compliance requirements in the hands of the employers.

(CA Kashif Ali contributed to this article)

Budget 2021 – The Big Bang Budget?

Equalisation Levy:

• EL was first introduced in 2016 at 6% on payments received by a non-resident service provider from an Indian resident (carrying on business or profession) in respect of online advertising, provision of online advertising space and related services.
• Last year budget introduced Equalisation levy of 2% of consideration received e-commerce operators’ goods and services. This levy created significant anxiety among e-commerce players and US even announced investigation under the applicable laws on the ground that it was discriminatory against US companies.
• One of the grounds of criticism was that section was widely worded to cover goods as also services enjoyed offline. To take an example, to negotiate goods and service agreement parties use digital / electronic means for confirming contracts, the delivery of goods and/or services is largely offline saying orders placed online for commodities such as oil on an e-portal. This would have unintended impact of levy of huge taxes   and that too on gross value and not profits.
• In view of above practical difficulties, Budget needs to clarify following:
• EL is restricted to digitalized and USs and services and does not cover goods and services which are physical in nature/services which are enjoyed offline and where e-commerce merely facilitates communication, placement, conclusion, or delivery of order.
• ESS EL is to be levied on the actual consideration that belongs to the e-commerce operator like commission, convenience feel, facilitation fees received from residents in India or non-residents using IP address in India.
• EL may increase cost of doing business without being entitled tax credit in the home country.
• India is a vibrant digital economy attracting huge investments in into e-commerce business. Some studies have estimated that and size of digital economy of India was $200 billion annually (Report of ministry of electronics and information technology-India’s Trillion Dollar Digital Opportunity, February 2019) All the more reason that the budget provide clarity on the subject matter to allay concerns of investors or levy may be deferred till all issues and practical.

Tax deduction under Section of the Income Tax Act:

• As per Section 194O introduced in the Union Budget 2020, an e-Commerce operator is required to deduct TDS at the rate of 1% of value of sales value of goods sold and services rendered, with effect from October 2020. Non-resident e-Commerce participants are exempted from the scope of this section.
• The purpose of the introduction of Section 194O is to widen the TDS base by bringing e-Commerce participants under the tax, as due to large number of e-commerce participants, it is difficult to identify each participant, and TDS will ensure that participants are identified and are not out of tax net.
•  There are practical difficulties in complying with the said section, some of which are listed below:
•  Where multiple ecommerce operators (ECO’s) are involved in a particular transaction.
•  Due to different definitions of tour operator/package under Income Tax and GST, there seems to be a conflict between provisions relating to tax collection at source. Given the business structure, mostly all ECO’s operate from a centralised location, but have taken GST registrations across India, just to comply with requirements under section 9(5) of CGST Act, wherein an ECO is treated as a ‘deemed supplier’ of no...
• For the purposes of this provision, gross amounts of sales and services collected by the e-commerce operator without making deductions. Therefore, for the seller, it would be the cost of the goods or service including the commission being collected by the operator, and for the delivery partner, it would be the delivery charges including the facilitation fee.
• However, this interpretation would result in excessive and in certain cases double taxation since the gross amount includes the delivery fee, the commission, and the convenience fee charged by the platform. This does not form part of the payment made to the e-commerce operator, but in any case, must be included in the gross amount on which the tax is levied and withheld.
•  The e-commerce operator would further pay tax on the convenience fee collected, the commission earned and the facilitation fee from the delivery charges collected. This results in double taxation on the transactions undertaken by the e-commerce operator.
• TDS deductions is required to be made on raising of invoices, but credit can be claimed along with filing of returns. Refunds are normally be given after significant lapse of time resulting in blockage of working capital of small businesses, who cannot afford.
• To ease above concerns, budget needs to clarify above and clear confusions on these accounts.

GST:

GST was a path breaking reform, but still is work in progress even after two years of enactments:

• GST portal though designed very well to ensure ease of compliances in terms of registration, filing periodic returns, claiming input credits, online assessments, e-way bill generations etc.
• However, number of issues surfaced while implementation, like us overloading of data and system crashes, automatic uploading of data from inputs claim data, invoicing and payments, filing of returns etc.
• Some of these issues are resolved but other issues are still being resolved.
• Rules prescribed are complex and confusing.
• Major part of business in India consists of informal sector, who are facing issues like lack of IT knowledge, decades of noncompliance, which they are not ready yet to shed.
• Even buyers are happy not to insist on invoices to save costs.
• Frequent tinkering in tax rates, multiple tax slabs are confusing and create interpretation issues and avoidable disputes.
• All these issues are discouraging potential taxpayers to comply with law.
• In the light of above issues, it is expected that budget may issue some clarifications, subject to approval of GST council:
• To reduce municipality rates to at the most three (I recently carried LinkedIn survey as per which 100% of participants voted for the rate slabs of 0, %5%,120r 18%)
• To simplify law, rules, and multiple complex issues
• System upgradation to ensure ease of compliances.
• GST has huge potential to increase tax collections, provided law is made simple, tax rates are reduced and digital tools like data analytics, artificial intelligence, reconciliation of online data of assesses available on direct tax data base, diligent analysis of database and enhances et intelligence. Budget should give impetus to fix glitches and realise full potential of GST.

Divestments/Privatisation of PSUs and PSBs:

• The government is holding substantial equity of 51% to 90% in PSUs and PSBs, most of which are listed and command high valuation with a strong balance sheets and sound business models.
• Every year’s ambitious targets for divestments are provided to raise resources and bridge fiscal deficits. Most f times targets are underachieved. Major portion of divestments were in the form of transfer of government shareholdings to cash rich PSUs, buy back of shares and higher dividends. Such divestments are like transfer of funds from one pocket of the government and are in nature of book entries.
• Last year highest ever target of Rs. 2,10,000 crores were fixed and as of date small amounts of 15440 crores had been achieved, leaving substantial gap in meeting fiscal deficit targets. Some of which was due to Covid-19, which resulted in sharp decline in share prices of these entities, leaving no option but to defer divestments.
• There may be light at the end of tunnel as big divestments are in pipeline and are in advanced stage of completion of the process. PSUs like LIC, BPCL, Air India, Concore, VSNL (non-PSU) and others are expected to materialise in the next financial year and budget is expected to fix higher target of sale realisation from these companies.

Monetisation of non-strategic assets:

• Government (including State Governments, Municipality) are   the largest holder of land and other properties which are lying unused or underutilised. Port Trusts, Airport Authority of India, Railways, Defence ministry. PSUs like ONGC, Oil marketing companies, GAIL, Coal India, telecom companies, (BSNL and MTNL) also large holding of such assets.
• Experts had been advising monetisation of theses idle assets. Government has shown also shown intention to unlock value of these assets no substantial progress had been made so far. Potential realisable value is estimated to be in the range of lacs of crores. This year is the right time to unlock value of these resources and utilise for much needed infrastructure development, healthcare, education etc for long term growth of India.

Monetization of enemy assets:

• Government is holding enemy assets consisting of 9400 properties of over 9400, estimated to have value exceeding Rs.1,00,000 crores.
• In the wake of the India-Pakistan wars of 1965 and 1971, there was migration of people from India to Pakistan. Under the Defence of India Rules framed under The Defence of India Act, 1962, the Government of India took over the properties and companies of those who took Pakistani nationality.
• Government can monetise these properties and utilise proceeds for investments in infrastructure and other key areas requiring substantial resources. Group of Ministry had been formed to monitor disposal of these properties. This process needs to accelerate to speed up realisation of money from disposal of enemy properties.

Auctions of spectrum:

• Telecom sector is one of the fastest growing sectors India and other countries. In terms of data usage Indians (including those living rural areas and small towns) are increasingly using data. Reasons for such an exponential growth area under:
• Data tariff is lowest in India, triggered by price war started by Jio.
• Mobile calls are either virtually free or have a low and affordable costs.
• Increasing adaption of online transactions
• Work from home due to COVID-19 induced has increased data usage.
• Change in consumer behaviours has resulted in increasing use of cell phone to buy all non and essential gods and services for groceries, provisions, fruits and vegetables, cell phones, increasing use of OTT platforms. Social media etc, necessitated by lockdown. This change in behaviour is going to stay for a long time.
• Government has monopoly over spectrum assets. In the past auctions, government has fix exponentially high reserve prices, which discouraged telecom to bid and hence response was poor. Proceeds from auction was significantly lower than budgeted.

1. India is on cusp of upgrading to latest 5G technology and there is expected to be huge demand for acquiring spectrum as and when auction is announced. In the light of past experiences, Government will price the spectrum at reasonable price to attract good response and pent-up demand. Accordingly, budget should make estimates on this account, taking into consideration above factors.

Sale of other non-strategic assets:

• Government is holding substantial shareholding in blue chip companies like L&T, ITC etc. without any control. These shares were originally held by UTI 64 schemes. Post Harshad Mehta scam, NAV of the scheme declined substantially.
• Most of funds of the scheme were held by retired and small investors for regular returns. Government could not have afforded to allow the scheme to fail as it would have put in jeopardy hard earned savings of small savers and with it loos of confidence and trust in Government. Hence, entire shareholding of the scheme was transferred to a special purpose vehicle namely SUT to be disposed in future to meet maturity claims of investors. On the same logic, government should dispose its shareholdings in hotels, Maruti and other such entities.
• The purpose of transfer has been achieved and Government needs to consider disposal of entre shareholdings in these entities and to utilise proceeds for developmental purpose.

Whether this budget make a big bang allocation to key developmental sectors?

• There are certain key sectors which are starving for funds and had been ignored in the past to keep fiscal deficit in check. COVID -19 has crippled these sectors and budget needs to make allocation of resources to these sectors on a priority basis.
• These sectors are listed below.
• Health care-COVID-19 caught India unaware and fragile legacy health infrastructure was exposed like never.
• This was a wakeup call to India and budget needs to substantially increase allocation to Health car. Past and existing allocations are significantly lower than the requirements.
• India's total healthcare spending at 3.6% of GDP, as per OECD, is way lower than that of other countries. The average for OECD countries in 2018 was 8.8% of GDP. Developed nations—the US (16.9%), Germany (11.2%), France (11.2%) and Japan (10.9%)—spend even more. To begin with allocation to this sector should b at least increased to 5% of GDP.
• Education-Education is critical to development of the nation, particularly when India has a sizable population of illiterate and under educated people.
• The share of education spending budget has decreased from 4.6 per cent in 2014-15 to 3.5 per cent in interim budget of 2019-20. As per estimates of expert, allocation to education in budget should be increased to at least 6% of GDP.
• Defence sector- The allocation to the Ministry of Defence is the highest allocation among all ministries of the central government. The expenditure on defence constitutes 15.5% of the central government's budget and 2.1% of India's estimated GDP for 2020-21.
• Defence sector needs substantial allocations to modernise armed forces, acquires latest technology equipment’s like fighter jets, Navy armoured ships and aircraft carriers, missiles, spending across long borders of China and Pakistan and fight terrorism.
• 0f the total allocation, revenue expenditure amounts to 75 per cent and capital expenditure 25 per cent. Significant part of allocation is towards salaries, pensions etc of defence forces and administration, leaving little scope for much needed capital expenditure.
• Defence sector allocation needs to be significantly enhanced to meet the requirements.
• Infrastructure sector mainly roads, railways, ports, freight corridors, airports. Infrastructure development is key to faster economic growth of the country and to substantially upgrade infrastructure to meet long term requirements of the country.
• Private investments though badly required, but at this juncture due to various constraints like lower capacity utilisation, lower demands, lack of availability of required funds many corporates are not able to spend and hence role of government is critical in infrastructure developments.

To sum up:

Now that budget is just a few days away, India is keenly looking forward to a big bang which will provide long needed stimulus and will be a growth-oriented budget. As of now, we wait and watch and be optimistic that budget meets countries expectations and will be a budget never seen before at least over 100 years as announced by FM.

Click here to read Part 1.

BUDGET 2021 – WHAT’S IN STORE

While the entire world has been going through a very tough and challenging time, the changes that have been witnessed in all walks of life have only led to new ways of living. On one hand there is a fear of pandemic and on the other hand the vaccines have arrived which will, hopefully, provide much needed relief from the pandemic.  

Since the lockdown was announced in March 2020 in India, the number of measures that have been introduced by the government have been manifold ... be it the extension of statutory limits for various compliance under different laws, re-look at the determination of residency rules for stranded employees, interest holidays, etc. Since the uncertain and ever-changing environment is here to stay that the measures are still being announced to bring the economy back on track and address the situations that have been faced as a result of the pandemic.

In the midst of all these, the government would push for the economic reforms, through the annual event commonly known as the ‘Budget’ and we deal with some of the budget expectations that may see the light of the day on 1st February.

COVID-19 measures

The law currently provides for deductions while computing gross total income of the taxpayer viz. medical treatment for self or dependents suffering from disability/severe disability, medical treatment of prescribed diseases and ailments, donation made to PM CARES fund designed specifically for providing COVID-19 relief.  Considering the fact that organisations/individuals would have spent huge sums on the treatment of COVID-19 related health issues, one may see an entire new deduction on account of the cost involved for Covid-19 treatment in government or private hospitals that could provide some relief to the taxpayers.

Taxation of dividends

Last year’s Budget witnessed a complete change in the taxability of dividends distributed by companies and income in respect of units of mutual fund or specified company. The ‘Dividend Distribution Tax’ (DDT) regime was done away with and interest expenses were capped at 20% of the aforesaid income.

While these amendments were met with mixed response, the restriction on the allowability of interest income was not well accepted and there were several recommendations made in that regard. In view of keeping parity with the principle of taxing only the net income, one may expect an amendment in regard to allowing the entire expenditure in earning the dividend income.

Equalisation Levy

While the ‘Equalisation Levy’ (EL) has been introduced with an objective of aligning with the OECD’s Base Erosion and Profit Shifting Action Plan 1, it has not been free from issues and one may expect greater clarity in this regard. Recently, the US administration announced initiation of investigation under Section 301 of the Trade Act, 1974 against the new 2% EL introduced by India.  In this regard, India had submitted its comments to the US Trade Representative. India participated in the bilateral consultation, emphasising that the EL is not discriminatory. On the contrary it seeks to ensure a level-playing field with respect to e-commerce activities undertaken by entities resident in India, and those that are not resident in India, or do not have a PE in India. It was also clarified that the EL was applied only prospectively, and has no extra-territorial application, since it is based on sales occurring in the territory of India through digital means. Further India clarified that it will examine the determination / decision notified by the US in this regard and would take appropriate action keeping in view the overall interest of the nation.

In the Budget, one may expect clarifications with respect to various issues relating to the EL for e.g. clarity on the scope of ‘ecommerce operator’, exemption for intra- group company transactions and reseller/ distributor arrangements, clarity on various terms like ‘digital facility’ or ‘electronic facility’ or ‘platform’, etc. The government may provide access to the normal appellate systems for disputes involving applicability and quantification of the levy. Similarly, an advance ruling mechanism may also be considered to help provide certainty to taxpayers as regards their liability to the levy.

Relaxation for residency test for stranded employees

Clarifications were earlier issued in respect of residential status of individuals for the Financial Year (FY) 2019-20 in clearing the ambiguity on residential status of individuals by taking into cognizance the concerns of such individuals who could not return back to their home country until 31st March 2020. The government may provide relaxation for residency test for stranded employees for FY 2020-21 in line with the earlier clarification issued for FY 2019-20.

Framework for faster resolution of disputes

The government is considering a new and continuous framework for faster resolution of disputes over direct taxes like mediation or a permanent dispute resolution system with pre-specified benchmarks on the lines of the ‘Vivad Se Vishwas’ scheme.

Deductibility of WFH expenditure

Work from Home (WFH) has been an order of the day during this pandemic. In order to set up dedicated work-stations at home for prolonged use, most employees also purchased work chairs, desks and reading tables. Further WFH employees have also been incurring certain work-related expenditure like internet charges, electricity, etc. Most organisations reimburse their employees for this additional expenditure either by providing a lump sum allowance or by providing actual cost reimbursements. Some of the developed countries like Canada has already provided relief towards home office expenses. It would be apt to provide clarity for deductibility of WFH expenditure / reimbursements in the hands of employer to avoid any future litigation.

Removal of Surcharge and Cess

Surcharge and Education Cess were introduced many years back and time has come to withdraw the same. This will reduce the burden of taxes and will leave a little more disposable income in the hands of taxpayer to spend or increase their savings.

Way ahead

While the government will have to manage a daunting task of meeting the expectation of the citizens of this country, it would also have to keep the fiscal deficit under control with an objective of fostering the growth engine of this country and protecting the interest of the people considering the current challenging times that lie ahead and are not done away with completely. Bringing certainty and clarity in tax laws will be helpful for the taxpayers.

Budget 2021: A Dozen expectations from TP perspective

This article has been co-authored by Amit Dhadphale (Associate Partner) and Swapnil Bafna (Senior Manager), EY India.

Almost two decades since introduction, the Transfer Pricing (TP) provisions in India have undergone significant policy introductions, such as Advance Pricing Agreements (APA), Safe Harbou6r Rules (SHR), introduction of Dispute Resolution Panel to fast track the TP litigation, introduction of secondary adjustment concept, introduction of acceptable range concept for computation of arm’s length price, introduction of three-tier documentation requirement on the lines of guidance by the Organisation for Economic Cooperation and Development (OECD) in its Base Erosion and Profit Shifting (BEPS) guidance, etc. With the introduction of new concepts and compliance requirements, the Indian tax authorities have brought the Indian TP Regulations (ITPR) at par with the international standards and practices, whilst significant overhaul to the ITPR is not required, based on practical experience, there seems to be a need to iron out some provisions to improve the experience of the taxpayers and improve the “ease of doing business” agenda for the Multi-National Corporations (MNCs). Moreover, managing the TP aspects in a pandemic impacted era requires additional guidance. With this backdrop, the MNCs are looking forward to the Budget 2021 with great expectations.

In the ensuing paragraphs, we have endeavoured to capture the expectations from Budget 2021 from a TP perspective:

A.     RATIONALISATION OF PROCEDURAL ASPECTS

1.      Shift to inter-quartile range

The ITPR experienced a welcome change by introduction of the range concept (35^th to 65^th percentile) for the comparables for evaluation of the arm’s length nature of the international transactions, as against the traditional arithmetic mean concept.  It is worthwhile for the Indian lawmakers to modify this to an inter-quartile range, i.e. 25^th to 75^th percentile to align it to the globally acceptable / implemented standards. Such an introduction will go a long way in providing wider range of acceptable comparable margins as well as reducing overall litigation in India.

2.      Rationalisation of Master File (MF) and compliance

Current MF provisions do not provide any guidance as to which categories of transactions need to be considered while calculating the threshold of INR 50 Crore for applicability of MF. Taxpayers have been left wondering whether transactions such as issue or subscription of shares, amount of loan availed during the year, amount of corporate guarantee, transactions that are not taxable in India, amount of trade receivables / payables, etc. needs to be considered for calculating such threshold or not. In order to resolve the ambiguity around calculation of the threshold of INR 50 Crore for applicability of MF, it is recommended that a clear guidance be provided in Rule 10DA on the nature of transactions to be considered, which may include alignment of such threshold computation to the aggregate value of international transactions from the Accountant’s Report (Form 3CEB) and related guidance on transactions mandatorily required to be reported in the Accountant’s Report.

Further, it is recommended that clarity be provided in relation to applicability of MF related provisions to foreign companies earning taxable income from India, whether transactions of such foreign companies with its Indian AE that do not result any tax incidence in India in the absence of PE (such as purchase or sale of goods, etc) need to be considered while working out the threshold of INR 50 Crore for applicability of MF, etc.

A further rationalisation of the MF compliance requirement is needed to clarify that one MF per Group should be considered as sufficient compliance with the requirement, since there is still a confusion as to whether a foreign entity can designate an Indian entity for the MF compliances.

3.      Relief from TP compliance for micro enterprises

As per current TP provisions, a taxpayer whose aggregate value of international transaction(s) is less than INR 10 million is exempted from maintenance of detailed TP documentation as prescribed under Section 92D read with Rule 10D of the Rules. However, such taxpayer is still required to file the Accountant’s report (in Form 3CEB) and also required to maintain limited TP documentation to substantiate the arm’s length nature of international transactions. This results in increase in compliance burden in the hands of taxpayers who do not undertake significant international transactions.  The authorities may evaluate increasing the above threshold to INR 5 Crores (in line with the new MSME[1] policy) and doing away with the entire set of TP compliances for such micro enterprises. 

B.     RATIONALISATION OF ALTERNATE DISPUTE RESOLUTION MECHANISMS

4.      Further rationalization of Safe Harbour Rules

SHR as revised in 2017 rationalized the prescribed rates of operating margins to be earned by eligible taxpayers from the prescribed categories of transactions and also expanded the scope of such SHR to include low value-added intra-group services and outbound loans in its ambit. In order to make SHR more attractive, it is recommended to further rationalise the rates prescribed under SHR till FY 2019-20, cover more categories of transactions and prescribe rational safe harbour margins to attract more takers for SHR to boost the “make in India” initiative and more particularly, prescribe special rates for the COVID-19 impacted years.

5.      Extension of APA to Specified Domestic Transactions

Current APA provisions apply only to international transaction and not SDTs.  In order to provide more certainty to taxpayers, scope of APA may also be extended to SDTs, since the principles and mechanism for evaluation of arm’s length nature remains the same for both such categories.

6.      Provision to keep TP audit or litigation provisions in abeyance till signing of APA

APA in India is undoubtedly one of the most successful APA regimes across the world. It has definitely provided the taxpayers much needed certainty from prolonged litigation in India. However, current provisions in the Act relating to the limitation of time for completion of audit proceedings as well as APA do not provide for abeyance of the audit or appellate proceedings during the time when APA is in progress/ discussions. Moreover, the pendency of the APA applications due to huge response and lower manpower in the APA team also results in conclusion of APAs in 3^rd to 5^th year of application (even further delays in some cases). 

This creates a lot of administrative hassle for taxpayer as well as tax administration to go through the audit proceedings and results in cost burden for the taxpayers in terms of payment of taxes and interest thereon, cost of defending case in audit or litigation, etc. Moreover, the taxpayers are required to deposit 20% of the outstanding tax demand for pursuing the litigation process under domestic law, which creates further hardship for the APA applicants.

In view of this, it is recommended that provisions be introduced to keep the TP audit / litigation proceedings in abeyance till the time APA proceedings are in progress/ discussions for the APA years as well as rollback years. In case such abeyance of litigation process is not feasible, it is alternatively recommended at least to introduce provisions to give 100% stay of demand in cases wherein the tax demand pertains to APA or rollback years.

C.     RATIONALISATION OF TP FOR FOREIGN ENTERPRISES

7.      Need for harmony in arm’s length price computation approach for foreign enterprises

While it is well accepted that the ITPR aims at protection of the tax base for India, the provisions require all the taxpayers to also undertake TP compliances, which results in the overseas Associated Enterprises (AEs) of the Indian taxpayers to all undertake the TP compliances if the income received by them from the Indian AE is taxable in India. Such foreign enterprises also undergo TP assessment and face TP adjustment, though, the same transaction for the Indian AE may be considered to be at arm’s length.  The MNCs have been relying upon the “tax base erosion” argument (aligned to the objective behind introduction of ITPR) by stating that with the increase in the income of overseas enterprise, there will rather be an effective reduction in overall tax base (provided that the foreign AEs are taxed at a lower rate than the Indian AEs).  However, Hon’ble Special Bench in case of Instrumentarium[2] has taken a view that application of TP provisions needs to be considered separately for each party to the transaction and not on overall basis. Such a view results in determination of two arm’s length prices for the same international transaction in India and any TP adjustment in the hands of either of the party to the transaction leads to double taxation in the hands of MNC Group in India, which is clearly against the intent of introduction of TP provisions in India as elaborated in Circular 14 of 2001. It is recommended that an appropriate amendment be brought in section 92(3) of the Act to clarify that application of TP provisions in India needs to be seen on an overall basis and not separately for each party to the transaction.

Alternatively, CBDT should consider introducing correlative adjustment provisions in Indian TP provisions to avoid double taxation in the hands of MNC Group in India. Such correlative adjustment provisions can be also extended to Specified Domestic Transactions (SDTs). 

8.      Clarity on TP compliances to be undertaken by foreign companies taxed in India on gross basis

Presently, under section 115A of the Act, foreign companies that earn income from India such as royalty, fees for technical services, interest, etc on which the taxes are withheld on gross basis using the rates as prescribed under Chapter XVII-B of the Income-tax Act, 1961 (‘the Act’), are exempt from the requirement to furnish its return of income in India. However, no such exemption is provided for their TP compliances in India. In order to ease compliance burden on foreign companies, it is recommended that such exemption be also extended to TP compliances in India for such transactions.

D.     POLICY FOR REDUCTION / RESOLUTION OF TP DISPUTES

9.      Need for harmony between TP provisions and Customs regulations

The Income-tax provisions aim at protecting the tax base for India, whereas, the Customs Regulations aim at collecting the appropriate customs duties on imports.  Thus, on one hand, the ITPR evaluate whether the import prices are overvalued (resulting in reduction of profits and thus erosion of tax base), the Customs regulations evaluate whether the import prices are under-valued (resulting in lower customs duties) and thus, in one sense, these regulations test the same transaction in opposite directions based on the specific provisions and objectives.  Such dichotomy is against the Government’s agenda of ongoing digitisation and exchange of information between various Government departments and hence, there is an immediate need to provide a mandate to the tax authorities to harmonise the arm’s length testing objective while conducting their respective assessments, which may also include a “single window” clearance of the import transactions by introducing an appropriate mechanism and authority for the same.

10.   Insertion of provision for “out-of-court settlement” in the Act

In line with the international practices[3], it is recommended that “out-of-court settlement” provisions could be introduced in India for the taxpayers who are willing to settle the TP disputes unilaterally, instead of going for Mutual Agreement Procedure or arbitration proceedings under the tax treaty. The Government may also consider introduction of a detailed code for mediation process, where the disputing parties may engage the assistance of an independent party (mediator) to arrive at a mutually acceptable resolution for the dispute.  This will help taxpayers to achieve certainty instead of going through the entire litigation cycle. At the same time, it will also help Government to clear the backlog of pending cases and unlock the tax demands (at least partially).

11.   Introduction of tax office consultation process in the Act

Similar to Advance Rulings, the CBDT could also consider introducing tax office consultation process in the Act, whereby small taxpayers can approach the jurisdictional assessing officer to discuss the fact pattern and agree on the arm’s length remuneration so as to avoid the disputes at a later date during the course of TP audits. Similar provisions are available in the Act in the form of SHR and APA, they have their own limitations. Whilst SHR are applicable only to prescribed eligible international transactions, small taxpayers find APA process expensive vis-à-vis the quantum of international transactions. In view of this, introduction of tax office consultation process could provide much needed certainty to the small taxpayers and also collection of the right amount of taxes.

12.   Special considerations for impact of COVID-19 on business:

Considering the hardship faced by various industries during the ongoing COVID-19 perspective, it is imperative that Budget 2021 provides certain guidance and stimulus to industries from overall taxation perspective, especially TP. References can be drawn from the ‘Guidance on the transfer pricing implications of COVID-19 pandemic’ released by OECD on 18 December 2020. In nutshell, Ministry of Finance should roll-out a clear guidance on various aspects such as:

(a)          Comparability analysis along with need to undertake economic adjustments,

(b)          Treatment of exceptional cost incurred by companies during this period,

(c)          Introduction of ‘term test concept’ to test the arm’s length nature of the international transactions undertaken during the COVID-19 pandemic period i.e. the tested party data should be considered for a block period (say, 3 years) and then it should be compared with three years data comparable companies,

(d)          Guidance on revision / amendment to signed APA’s and negotiation for new APAs.

The above discussed TP provisions related proposals would be far reaching, if implemented in the Union Budget 2021 and would improve “ease of doing business” objective of the Government of India.

(Disclaimer:  The views and opinions expressed in this article are those of the authors and do not necessarily reflect the view of the firm.

TP Vaccine in Union Finance Budget 2021 and beyond

This article has been co-authored by Prateek Goyal (Senior Manager), Ernst & Young LLP.

COVID-19 and its continuing effects have significantly impacted business and consequently the economy. India’s GDP collapsed by 23.9 percent in the first quarter of fiscal year 2020-21[1] amid lockdowns, though strong signals of economic recovery were seen in the second quarter when contraction rate fell to 7.5%[2].  The road to the union budget is always laden with high expectations. 2021 has dawned anticipating a strong dose of fiscal vaccine to treat the country’s economic health to supplement the medical vaccine treating the virus.

The Finance Minister is expected to lay out a detailed roadmap for economic revival which will most likely cover multiple aspects such as Aatma Nirbhar Bharat, Make in India, dip in economic growth, slump caused by COVID-19, provide further stimulus, boost exports, generating more FDI, ease of doing business in India, etc.

Although measures introduced in the previous budget such as tax sops through revised tax regime, Vivad Se Vishwas scheme etc. found favour with various corporate taxpayers, the expectation of India Inc. and foreign investors from Budget 2021 would be relief in the backdrop of COVID-19, easing compliance burdens, fast tracking dispute resolution and offering certainty and predictability in taxes.

We believe the Government and policy makers could consider the following measures in planning for the budget and beyond.

1.       The COVID Cure - Anticipated reliefs considering impact of COVID-19 pandemic

The disruptions caused by Covid forced business to change the way they operate, be it altering supply chains, managing decreased demand, carrying unutilised capacity, incurring non-routine costs etc. Overall, it has put a lot of pressure on financial results industry wide and has necessitated changes to transfer pricing policies within groups.

While the entire industry was in same boat, the shockwaves shook companies in different ways, and we are likely to see varying impact on companies’ profitability depending upon scale, capabilities, cash reserves and access to resources. Hence, the arm’s length analysis for financial year 2020-21 has to consider business realities and provide for exceptions.

Legislative changes:

·  Relaxation in limitation of interest deduction u/s 94B (Thin capitalization): As per section 94B of the Income Tax Act, 1961 (‘the Act’) the interest paid to AEs is allowed as deduction subject to the 30% of EBITDA rule. Funding has been adversely impacted and companies may have sought additional money from related parties to fund working capital. EBITDA on the other hand, is likely to have reduced. On balance, lesser deduction and more carry forward of interest may be a consequence. Additional tax liabilities in a difficult year may not be welcome and this provision could be relaxed. Similar reform has been introduced by the United States under its CARES Act, which allows the taxpayers to increase the 30% of adjusted taxable income (ATI) limitation on business interest expense to 50% of ATI for any tax year beginning in 2019 or 2020[3].

Non-legislative changes: Some of the below changes may not require amendment in Act and can be brought through changes in Income Tax Rules or appropriate notifications in the form of additional guidance. Timely introduction of these changes will greatly help industry.

·   Expanded Tolerance range: Currently, where the number of comparables is more than 6, the arm’s length range as per the Rules is from the 35th percentile of the data set of the comparables to the 65th percentile of the data set. Where number of comparables are less than 6, the tolerance range is 3%. This tolerance range can be relaxed in both the above scenarios, such as 25^th to 75^th percentile (aligned to international standards) and 5% range (similar to erstwhile range), in case comparables are less than 6.

·  Multiple vs. Single year data: The law mandates use of multiple year data (i.e. current year and 2 prior years) to compute margins of comparables for an arm’s length analysis. Considering the extra-ordinary economic circumstances of FY 2020-21 and onwards, the multiple year data requirement may be substituted with single year data specific to the year which would reflect the actual arm’s length scenario prevailing in that respective year. TP compliance deadlines could be extended appropriately to ensure availability of that respective year data in public domain.

·  Extra-ordinary costs and operating losses: Organizations have incurred significant amount of idle cost during the period of lockdown or had to incur some extra cost to sustain their operations after the lockdown was relaxed. Such additional costs should be allowed to be treated as non-operating or abnormal while computing margins, subject to maintenance of appropriate documentation/evidences by the taxpayers.

·  Revision of pre-agreed Advance Pricing Agreements (‘APAs’): The APA terms (critical assumptions, financial projections, pre-agreed margins etc.) on which transactions were originally entered and agreed with the Central Board of Direct Taxes (‘CBDT’), may not be met / remain the same due to changes in the external environment. These changes may make the APA infeasible. Rule 10Q, Rule 10M(4) and Rule 10M(5) of Income tax Rules provides an option to CBDT to revise the terms of an APA, either suo-motu or on request from the assessee or competent authority in India or the Director General of Income-tax (International Taxation) or competent authority in the other country (in case of bilateral or multilateral APA). CBDT could possibly address this as follows:

- Where variance in reasonable or minor – Similar to New Zealand, CBDT may provide relief by allowing assessee to take crucial business decisions that may be considered as arm’s length and such changes not be considered as breach of the APA. Further, such changes may be disclosed by the Assessee during the time of Annual Compliance Report (“ACR”) and any breach may be reviewed by the APA authorities on a case to case basis and allowed.

-  Where variance in major – A fast track window may be created to review variances and incorporate potential revision to reflect COVID led realities and give necessary reliefs.

·  Liquidity: No notional interest should be computed in case of genuine delayed/outstanding receivables from related parties during FY 2020-21 to provide greater liquidity to the business.  

2.       Alternate Dispute resolution

The Government has been committed to a non-adversarial tax regime and has taken steps to reduce controversy and provide certainty to taxpayers. To further progress on this path, additional measures could be considered.

Legislative changes:

·  Mediation[4]: The Task Force appointed for drafting a new Direct Tax Law had recommended a mediation framework to provide taxpayers an opportunity of a negotiated settlement. This will help resolve potential disputes early in the controversy lifecycle and relieve pressure on the judicial machinery.

·  Strengthening the APA framework: APAs have been a huge success and the utility of this forum can be enhanced by considering the following changes

-       Keeping regular transfer pricing (TP) assessments of covered years, in abeyance, until conclusion of APA

-   Removal of restriction on downward adjustment under section 92(3) of the Act for APAs/ Mutual Agreement Proceedings (MAPs) cases

-     Explicit clarification to be provided to taxpayers from non-maintaining TP documentation/filing Form 3CEB, where an APA is already concluded, and the applicant is filing the Annual Compliance Report (ACR) in respect of the covered transactions.

-   Removal of restriction on applicability of rollback for years where the taxpayer has filed a belated tax return.

Non-legislative changes:

·   Advance Pricing Agreement:

-   In situations where APA agrees to the arm’s length price for transactions like royalty payments or payments of technical service fee by Indian taxpayers to its foreign related party, changing the transaction value for the past in APA introduces additional withholding taxes having been paid but not refundable since the foreign related party subject to the withholding tax is not the applicant in APA. Having recognized that the APA is an agreement with the Government and modification to the transaction price has been negotiated and agreed, it is imperative that the excess withholding tax be refunded to the applicant group appropriately. A suitable framework should be introduced to alleviate the hardships faced by companies in this respect.

-  Government should bring about a parallel process of obtaining a fast-track APA channel which would be beneficial for new potential investors wherein TP certainty is key for foreign investment decision for India as country.

- It may be clarified that APA (including rollback) is available in a merger situation or when an applicant converts into a Limited Liability Partnership (LLP) provided there is no change in functional and risk profile in respect of the covered transactions

- Arm’s length price as agreed by CBDT under APA must be respected by CBIC for customs valuation and vice-versa

·  Revision in Safe Harbour regime: Previously introduced Safe Harbour Rules could not find much traction amongst taxpayers due to higher rates/margins. To make the scheme more lucrative and appealing to taxpayers, lower rates reflecting changed business realities could be prescribed.

3.       Ease in compliance requirements

Ease of doing business in India should be reflected in reduced compliance burdens for corporate taxpayers especially multinational companies.  

Legislative changes:

· Exemption from TP documentation/Form 3CEB requirements to foreign companies with taxable transactions in India: In cases where base erosion principles apply, explicit exemption from TP documentation and Form 3CEB compliance requirements can be provided to foreign companies.

·   Country-by-Country Report (CbCR) - In cases where a consolidated group is not required to file in its parent jurisdiction but crosses the threshold in India due to exchange rate differences, the India company may need to file the CbCR in India. This is administratively burdensome. It should be clarified that this is not the intent of the law and no penalty would be levied in such cases.  

Non-legislative changes:

·  Master file designation: Under the current provisions, designation for Master File filing (Form 3CEAB) is possible only if there are “more than one” “resident” constituent entities (‘CEs’). This scope of master file designation can be further extended to cover foreign entities even in scenarios with only one Indian constituent entity (CE).

The geo-political and economic climate is dynamic. Reforms need to be timely to maximize benefits. The time is ripe for enhancing India’s attractiveness as a business friendly jurisdiction by offering a rational, predictable and conflict free environment. Also, recognizing the hardship imposed by Covid-19 on businesses and treating FY2020-21 as an exceptional year will be the sign of a compassionate Government. The ball is in the Government’s court.

*Authored by Ashwin Vishwanathan (Partner) and Prateek Goyal (Senior Manager) from Ernst & Young LLP. Ankur Chandak, EY tax professional also contributed. Views are personal.

Transfer Pricing Impetus in Budget 2021

This article has been co-authored by Shefali Shah (Director), Transfer Pricing Services, Deloitte Touche Tohmatsu India LLP.

The year 2020 was one of the most unprecedented years indeed for everyone. With COVID, the past one year was challenging for the economy in many ways including keeping the work force safe, adopting to the digital way of doing business, keeping the business going etc. Considering the various challenges faced by the economy, India Inc. is looking forward to the Union Budget FY 2021-22.

According to a recent survey conducted by Deloitte Touche Tohmatsu India LLP, respondents expect a strong push in the budget for the economy, business, and industry. Of the 180 survey participants, 68% industry leaders are positive about India’s economic revival. Respondents believe that the mass vaccination drive, the government’s stimulus packages and other policy changes, focused attention to infrastructure, and continuing efforts on digitization are some key areas helping India revive and thrive.

As a road-map to economic revival, in the article below, we have captured the Transfer Pricing (TP) wish list from the Union Budget FY 2021-22.

1.COVID impact - Rationalisation measures in determining arm’s length price (ALP) 

The pandemic has affected every business in some or the other way. Companies have faced various challenges and adopted several measures to meet the forecasted sales, profit or cash flow numbers. Few companies severely hit by the pandemic, the sole moto was to survive through these tough times. Many group companies have helped each other to come through this. Considering this, India Inc. is looking forward to the Union Budget 2021-22 to provide some Transfer Pricing rationalization measures that could be adopted by the taxpayers in determining arm’s length price (ALP) for this peculiar year. The wish list is as follows:

a) Widening the tolerance range from 3%: Indian TP regulation provides an acceptable tolerance range for the variation between the arm’s length price and the transaction price. The Central Board of Direct Taxes (CBDT) has notified the “tolerance range” of transfer price for the assessment year 2020-21. It has re-notified the prevailing 1 per cent tolerance range for wholesale trading and the 3 per cent range for all other transactions undertaken during the financial year ending March 31, 2020. Increasing the tolerance range will provide some cushion to the companies to meet the ALP. This year deserves a tolerance range of atleast around 7-10%.

b) Increasing the quartile range from 35^th to 65^th percentile to 25^th to 75^th percentile: Rule 10CA provides that where in respect of an international transaction, the application of the most appropriate method referred to in section 92C(1) results in determination of more than one price, then, the transactions would be considered to be at ALP if the said transaction falls within the arm’s length range of 35th and 65th percentile. This range could be increased to 25^th to 75^th percentile. This would help more companies to come under the ALP ambit. Also, this would be in line with the internationally followed inter-quartile range concept.

c)  Use of multiple year data (term test) /single year data: The Indian TP regulations, allow the use of multiple year data of comparable companies to determine the ALP. The use of multiple year data allows for yearly variations to be averaged out.  

However, given this peculiar year, the Government should allow use of similar multiple year data period for the taxpayer vis-à-vis the comparable companies in order to determine the ALP. Another suggestion would be to consider the single year financial data for this peculiar year for the taxpayer as well as the comparable companies. The challenge however in both cases would be to get financial data of this peculiar year while undertaking the TP documentation. Most companies financial data is publicly available only after the TP compliance due date. Therefore, such unavailability of financial data may pose a serious difficultly on the taxpayer to defend its transfer price and may lead to increased litigation. In order to resolve this guidance should be provided by the CBDT to carry out a “term test” taking the tax payers data for three years and comparables data also for three years, but the latest year being allowed some economic adjustments. In Singapore, the IRAS (Revenue) has been amenable to consider ‘term testing', i.e., testing the margins of the tested party over multiple years (usually over three years), for taxpayers who have specifically requested the IRAS for such ‘term testing’. In the current COVID-19-related guidance also, the IRAS allows use of ‘term testing’ for 2021, in cases where testing of single-year margins may result in volatile results due to the impact of COVID-19 without requiring any specific request for the same to the IRAS. However, the IRAS has cast the responsibility on the taxpayers to substantiate the need for the use of term testing through appropriate evidence. The IRAS also requires the taxpayers to clarify how term-testing was applied in their cases and state in the documentation that this is a ‘one-off event’.

d)  Rationalisation of the safe harbour rates: The government should consider to rationalise the safe harbour mark-ups to take into consideration the impact of the pandemic as well.

e)  Increasing the thin capitalisation threshold: In order to meet financial obligations in these trying times, Indian companies could have borrowed huge sum of moneys from financial institutions or related parties. Increasing the thin capitalisation threshold under section 94B of the Act would help companies that have been cash strapped during this pandemic.

f)  Guidelines on economic adjustments / treatment of extra-ordinary costs: The Organization of Economic Co-Operation and Development (“OECD”) had released guidance on COVID-19’s impact on Transfer Pricing. Likewise, the CBDT should also issue some guidance on the various economic adjustments that can be considered to nullify the effect of the pandemic. Some economic adjustments would include idle capacity, working capital, foreign exchange, interest on default of payments / loans etc.

Further with regard to extra-ordinary or abnormal cost guidance should be provided that the same be excluded from the margin calculations of the tested party and comparables to the extent identifiable from the financial statement. The disclosures made on account of the Impact of Coronavirus on Financial Reporting and the Auditors Consideration (ICAI COVID-19 advisory on financial reporting) could be helpful in identifying any extraordinary or abnormal cost, while recognizing that such disclosures would be a post-facto event.

Any guidelines on the above aspect would surely help the taxpayer and reduce protracted litigation, if any.

2.Advance Pricing Agreements (APA): An impetus could be provided to the APA scheme to make it more attractive. Few suggestions are as follows:

a) The government could consider to amend the APA rules to say that no litigation for companies that have applied for APA for the years under APA consideration;

b) The pandemic has delayed companies aspiring to opt for the APA scheme. Additional APA team across locations may help to fast track the APA process;

c) Set up of a special cell for revision of APA for companies impacted by COVID. This will provide immediate respite to companies where the APA has been breached due to the COVID impact;

d) APA program should discourage issuing lengthy questionnaires and warranting voluminous documentation, rather should use the site visit mechanism to gather an understanding of the business and the arrangements;

e) The APA teams should be evaluated based on the cases disposed as that would motivate them to take quick and practical positions.

3. Guidelines on financial transactions: The OECD has released guidance on financial transactions. Indian companies are subject to litigation on a number of financial transactions. Guidance from Indian perspective on such financial transactions would be of much help for companies in determining the ALP as well as reduce protracted litigation. 

4. Harmonisation of Customs and TP: Customs and TP authorities both have different perspectives while analysing the transactions undertaken by the taxpayer. Some harmonisation between Customs and TP will ease the taxpayer’s compliance burden.

5. Dispute Resolution: The tax payer also has certain wish list from a dispute resolution perspective. These include:

a) Block assessment for a period of 3- 5 years. This would reduce the litigation burden on the taxpayer as well as the tax authorities.

b) Introduction of settlement mechanism (like the Vivad se Vishwas Scheme launched by the government last year) for transfer pricing matters in the income-tax statute on a more permanent basis than with a limited time frame.

c) Currently the Dispute Resolution Panel (DRP) order is binding on the Assessing Officer and the department cannot appeal against the DRP order. Therefore, a taxpayer opts the DRP route only as a fast track to the Income Tax Appellate Tribunal (ITAT). Few changes should be made to make the DRP process (like give more powers to the DRP members to decide the case on meritorious basis) to make it an efficient route and thereby decrease the burden on the ITAT. If it is not possible to achieve that within the current framework of the DRP mechanism then the same should be replaced with an independent mediation mechanism. There was a high expectation of this to be released in the last budget and we hope this sees the light of the tunnel this year. On the portal of Taxsutra I had written a detailed article titled: “Mediation” - A Probable New Card in the Alternate Dispute Resolution Pack?” on January 30, 2020 which can be referred to gain further understanding on how this could work

d) Doing away with a minimum 20% demand payment before appealing for stay in ITAT – this definitely needs a relook considering that in many cases the issues are squarely covered in tax payers favour and may not warrant payment of any tax demand

e) Quicker resolution under MAP / APA

f) Publicly make available the TP risk parameters that may put the tax payer on a high risk of TP audits. This will help the companies to understand the position of the revenue authorities and provide an opportunity to proactively avoid litigation and ensure that the transfer pricing policies are not such that will result the taxpayer to fall into the pit of disputes. Assuming that this pit cannot be avoided, understanding these risk parameters can also help tax payers gear up for a likely audit.

There are a lot of expectations from this Budget from various stakeholders. It will be interesting to see if few of the above expectations to ease out the Transfer Pricing compliance and litigation burden forms part of the fine print in the upcoming Budget on 1^st February, 2021.