Coalition of Tax with Company law
 

In a major overhaul of corporate laws in India over the last couple of years, the Companies Act, 2013 (‘New Act’) appears to have been making a steady headway in the regulatory regime, gradually replacing the Companies Act, 1956 (‘Old Act’).  To avoid teething troubles, provisions of New Act have been notified gradually – either replacing the corresponding provisions of Old Act or providing a transitional period for implementation of new provisions. 

While there are some overlaps between old and new provisions as well as uncertainty over the applicability (or otherwise) of the new provisions, MCA has been quite responsive in attempting to clarify the position through series of circulars/notifications over the last few months.  Although the New Act does appear more dynamic in its form, intent and application there is a need to align it with the other laws, notably the Income-tax Act, 1961 (‘IT Act’).   To ease mismatches between the two laws, it would have been worthwhile for the Finance Minister to consider some of the suggestions below while presenting Budget 2014.

New Act provides for merger between Indian companies and foreign companies incorporated in notified jurisdictions.  IT Act does provide for tax neutrality qua mergers where the final existing company is an Indian company.  Similar tax neutrality could be provided in IT Act qua Indian shareholders of an Indian company which could get amalgamated with a foreign company under New Act.  

Corporate Social Responsibility (CSR) spends mandated by New Act ought to be dealt by IT Act for deductibility while computing taxable income.  With the net profit threshold limit pegged at a mere Rs 5 crores, a significant number of companies are likely to come under CSR net and would be required to mandatorily spend 2% of their average net profit towards specified CSR activities.  The moot issue here is whether such expenditure strictly qualifies as ‘expenditure incurred for the purposes of business’ of the company.  While judicial precedents may advocate such deductibility on the ground, the Finance Minister has, regrettably, clarified in Budget 2014 that such CSR expenditure would ‘not’ qualify as a tax deductible expenditure under IT Act.  This may impact profitability of companies and effectively decrease distributable profits.

The New Act provides for revision/restatement of financial statements for past years which could impact the minimum alternate tax (‘MAT’) liabilities due to change in reported profits.  This may require filing of revised income-tax return for the respective year(s).  Under IT Act, a company can revise its income-tax return up to two years from end of relevant financial year.  Accordingly, IT Act may need to be amended to provide that MAT should be payable only on the basis of accounts originally filed with tax return and any subsequent revision/restatement of financial statements under New Act for any earlier year(s) should not impact corresponding MAT liability of any of those year(s). 

The New Act provides that company can give a loan to a related party at an interest rate which should not be lower than the prescribed yield on Government Security closest to loan tenor. While IT Act does have transfer pricing mechanisms to benchmark such interest pay-outs between related parties, there is no such prescribed threshold. Accordingly, to avoid uncertainty over arms length pricing, it would be worthwhile to amend the IT Act and provide the same threshold for such interest pay-outs between related parties.

Further, IT Act provides for taxing buy-back of unlisted shares for the difference between original cost of investment in shares of the company and the buy-back consideration.  However, an exemption ought to be made from this rule for buy-back made out of securities premium under New Act. 

It is implicit that in his debut Budget, the incumbent Finance Minister has definitely faced a formidable challenge between spurring economic growth on one hand and curbing inflation and fiscal deficits on the other.  Nonetheless, incorporating the aforesaid suggestions would definitely aid in ironing out unintended impediments between two vital regulations and provide a more stable regime for all stakeholders concerned.  This should bode well for the long run.  We hope the Finance Minister would consider the above points in his run up to Budget 2015 which is not so far from now.

Deemed international transaction - Escape Route Plugged

Introduction

While presenting the first Union Budget of the new government, the Finance Minister mentioned in the inaugural part of his speech that ”the people of India have decisively voted for a change”, which marked the expectations of the people of India from the new government. The Union Budget was the first opportunity for the new government to exhibit its commitment to the improvement of business sentiment and overall development of the Indian economy. And one would say that the FM has undoubtedly lived up to expectations – especially on the transfer pricing (TP) front, by rationalizing various TP provisions in line with the international best practices.

In the recent past TP, was one of the major areas of litigation and a cause of concern for Indian and multi-national companies operating in India. However, the roll-back provisions introduced with respect to the Advance Pricing Agreement (APA) scheme would further boost the positive sentimentcreated by the APA scheme. Similarly, the amendments relating to the use of multiple-year data and introduction of the range concept for benchmarking satisfy the long awaited expectations of the taxpayers and would ensure thatthe overall transfer pricing benchmarking exercise appropriately captures the business realities.

Within the aforesaid overall positive changes, the FM has also introduced one amendment which may not be viewed by the taxpayer fraternity most favourably; i.e. roping in the transactions between two resident entities within the ambit of the term ‘deemed international transaction’. This is explained below.  

Deemed International Transactions – Current Provisions

As per Section 92B(1) of the Income-tax Act, 1961 (‘the Act’), the transactions between two associated enterprises (‘AE’) are covered within the ambit of Indian transfer pricing regulations, subject to other conditions stated therein.

Section 92B(2) of the Act created a deeming fiction to state that in relation to the transaction of a taxpayer with a person other than an AE will deemed to be a transaction between two AEs if there exists a prior agreement in relation to the relevant transaction between such other person and the AE, or the terms of the relevant transaction are determined in substance between such other person and the AE. The intention of this section is that taxpayers should not escape the rigors of transfer pricing in cases where the transaction when viewed in isolation appears to be between independent parties, but the same is influenced by a related party.

This is illustrated by way of following example

In the above illustration, A Inc. is a USA based company having a 100% subsidiary in India i.e. B Ltd. A Inc. has entered into a global procurement contract for certain software from C Inc. for all its group companies across the globe. Pursuant to the said contract, B Ltd. directly purchases the software from C Inc. at the prices agreed in the contract between A Inc. and C Inc.

In the above scenario, the transaction relating to purchase of software by B Ltd. from C Inc.; though between unrelated parties, would still be deemed to be an international transaction as it has been influenced by A Inc.

The Controversy

In the above example, there was no doubt on the applicability of the deeming provisions when C Inc., which was a third party was based outside India. However, in cases where the third party with whom the taxpayer would transact was based in India, there was an uncertainty on the applicability of the deeming fiction. Thus, to illustrate let us assume that in the above example A Inc. has a global contract for software purchase with C Ltd. which is an independent third party based in India.  The price at which B Ltd. acquired the software from C Ltd. was as agreed in the global procurement contract between A Inc. and C Ltd. The said arrangement is diagrammatically represented below

In the above case, since the transaction between B Ltd. and C Ltd. was influenced by A Inc., the deeming fiction under Section 92B(2) of the Act would kick in and the said transaction of B Ltd. with C Ltd. i.e. an independent party would be deemed to be a transaction between 2 AEs.

However, Section 92B(1) of the Act, which defines the term ‘international transaction’ essentially has two limbs i.e.

-          Transaction has to be between associated enterprises; and

-          Either or both should be non-resident

In the above scenario, though the first limb of Section 92B(1) i.e. transaction between two AEs would get satisfied, the second limb of Section 92B(1) i.e. either or both of the parties to the transaction ought to be a non-resident would not get satisfied. On this premise it was argued that the requirement of Section 92B(1) was not getting fulfilled in its entirety and hence, though the said transaction would be deemed to be between two AEs, the same would still not be considered to be an international transaction and hence, not subject to the transfer pricing regulations in India.

The aforesaid view also found favour of the Income-tax Appellate Tribunals[1] which held that for a transaction to be considered as a deemed international transaction; either party has to be a non-resident. Thus, under the existing scenario, it was possible to argue that the transaction between B Ltd. and C Ltd. would not be considered to be an international transaction and hence, would not be subject to the Indian transfer pricing regulations.

 The Change

Section 92B(2) now proposes to amend to provide that the transactions of a taxpayer with an independent party would be deemed to be an international transaction when either there exists a prior agreement with respect to that transaction between the AE of the taxpayer and such third party or the terms of such transaction are determined in substance between such other party and the taxpayer’s AE; irrespective of the fact whether such third party is a non-resident or not.

The amended Section 92B(2) would now read as under:

“A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be an international transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise where the enterprise or the associated enterprise or both of them are non-residents irrespective of whether such other person is a non-resident or not”

Thus, if the above illustration was considered, under the amended provision, the transaction between B Ltd. and C Ltd. would be subject to the Indian transfer pricing regulations.

Conclusion / Impact

The amendment has been proposed to plug a loophole in the existing law wherein certain taxpayers were able to escape the applicability of transfer pricing provisions with respect to transactions between two resident entities, even though the overseas related party had an influencing position in the overall scheme of the transactions. Thus, now all the transactions would be seen in their entirety rather than in isolation. This will require some taxpayers to relook at their domestic arrangements which are effected at the behest of their overseas associated enterprises. One of the transaction that could possibly been intended to  be covered by this amendment would be the merger or slump sale of business units between Indian arms of foreign MNCs, emanating out of a global deal struck between the parent companies. However, a technical point that could arise is that there is no direct arrangement between the AE of the enterprise and the third party in India.

Similarly, another scenario where this amendment could have implications is a case where a global auto manufacturer purchases auto components from a supplier based in India under a global arrangement. In such a case, the purchase of components by the Indian subsidiary of the auto manufacturer from the third party supplier in India pursuant to the global arrangement would be construed as ‘deemed international transaction’ and be subject to Indian TP regulations post the amendment to the regulations.       

Thus, the proposed amendment would provide teeth to the tax department to rope in all such future transactions within the gamut of Indian transfer pricing regulations and ensure that the transfer pricing regulations are implemented in their true spirit.  

* Dr. Hasnain Shroff, FCA;

  Kumar R. Sampat, ACA

[1]Kodak India Pvt. Ltd v. ACIT(ITA No. 7349/Mum/2012)

Swarnandhara IJMII Integrated Township Development Co. Pvt. Ltd v. DCIT (ITA No. 53/Hyd/2014)

Impact of Budget 2014 on PE industry

In the backdrop of political stability, the PE industry was expecting a reform oriented Budget, with a focus on stable and non-adversarial tax regime. At the same time, the indicators in the Economic Survey have not been very encouraging – with slowing growth, low GDP ratio, high inflation, monsoon risk and so on.
The FM has had a fine balancing act to perform and he did announce some positive measures. To start with, in line with the prevailing sentiment, FDI limits have been proposed to be raised. In defence manufacturing and insurance, the sectoral caps have gone up to 49% from 26%. The conditions applicable in case of FDI in real estate have been considerably eased and this should lead to real estate activity picking up steam.
On the tax front, the most promising announcement has been on characterization of income of FPIs/ FIIs. It has now been specified that gains arising to FPI/ FII from sale of securities shall be regarded as capital gains; thereby ending the uncertainty regarding the same being classified as business income and being subject to higher tax in India in certain cases. This is a very welcome move and should encourage offshore fund managers who have been operating from outside India for protecting FPI/ FII from adverse tax exposure, to shift base to India. This in turn should, over a period of time, have a positive effect on the emergence of India as an international financial center. Having said that, FPI/ FII availing of capital gains exemption under any treaty would still need to make sure that they meet the necessary substance criteria in the respective treaty jurisdiction to avail the beneficial tax treatment. Further, going forward, FPI/ FII may not have the option of classifying their income as business income, even if they may prefer to do so.
Secondly, a partial tax pass thru regime has been introduced for REITs and Invites. Interest income is not taxed at the REIT/ InvIT level, and is subject to withholding tax on payment by REIT/ InvIT to unit holders. But capital gains is taxable at the REIT/ InvIT level. This would mean that the foreign unit holders in REIT/ InvIT shall not be eligible to claim beneficial provisions of treaty in respect of capital gains. Further, units of REITs/ InvITs shall be treated akin to listed shares for taxation/ STT purpose in the hands of the unit holders.
On the negative side, the holding period for unlisted securities to qualify as long term has been extended to 36 months. There has been a change in the method of computation of DDT, which has resulted in a higher outgo of approx. 3.5% on account of DDT.
More importantly, the PE industry was expecting some relaxation on GAAR and a roll back on retrospective taxation of indirect transfers. On both these fronts, unfortunately, the FM has not provided any relief. On retro taxation, while he did spell out that going forward the Government would avoid retro taxation, at this point of time, there is not much clarity on how retrospective taxation of indirect transfers would be addressed. Also, tax pass thru status has not been extended to other AIFs; and continue to be applicable only to VCFs.
Inspite of some of these misses, at a macro level, the thrust is on introducing measures to revive the economy, promoting investment in manufacturing and rationalising tax provisions to reduce litigation. All this put together should augur well for the PE industry, in the long run.

Budget 2014 - What's in for the Indian Defence Sector

Defence is one of the priority areas for spending by the Indian government, given the precarious internal security scenario; hostile neighbourhood and an outdated inventory of the fighting forces which are some of the factors leading to a major modernization drive.
In the backdrop of Finance Minister holding dual portfolio of Defence and Finance, high pitched talk on strengthening the armed forces coupled with its increased proactiveness through the circulation of a cabinet note on defence FDI within the first few days of its taking charge, one can say that the budget expectations around Defence sector were significantly heightened. As against these expectations the Budget may have slightly demotivated the players in the sector.
The Finance Minister has proposed to increase the capital outlay for Defence by Rs. 5,000 crore (approx. USD 8.3 million) over the amount provided for in the interim Budget. The government has decided to allocate Rs.2,29,000 crore (approx. USD 38.3 billion) for the current financial year for Defence which implies a 12% rise year on year.
Increased defence expenditure coupled with measures to spur and revive the economy are the key takeaways from today’s budget. Setting the impetus on modernization, the Finance Minister has also announced that urgent steps would also be taken to streamline the procurement process to make it speedy and more efficient. Taking cues from the these budget changes, it is anticipated that some of the large deals in pipeline such as 197 light utility helicopters, 56 naval helicopters, Scorpene submarines, MMRCA deal amongst others may get cleared.
On the policy front, major revamps were expected in terms of an increase in FDI cap beyond 51% bestowing greater flexibility with the foreign party. The policy thus far capping the FDI limit at 26% did not offer any room for control by the foreign party with minimal participation in the India venture, resultantly disincentivizing the transfer of critical technologies by the OEMs to the Indian venture. The Government has failed to address these expectations by raising the cap from 26% to a mere 49% while retaining the conditions of Indian ownership, management and control. Consequently, the foreign investor shall continue to have minority control and management participation in the Indian entity. An OEM would view the increase in FDI cap as a dampener as it does not meet his expectations to more actively participate in the Indian Defence joint venture.
One can only hope that the Government shall consider further enhancing the cap to 51% or dispensing away with the conditions of Indian ownership and control conditions in future revisions to the FDI policy.
FDI is essentially a need-based concept. Whereas India needs FDI for accelerated growth, prospective investors are guided mainly by economic considerations. It is important, therefore, to cater to the interests of both parties and understand the perspective of our Government as well as the perspective of the potential investor. Both need to be harmoniously constructed to come out with a comprehensive and workable policy.
It is imperative to take cognizance of the fact that different policies do not work in watertight compartments. All relevant policies affecting the sector need to move in sync, which is, in essence, the real catalyst for indigenous manufacturing. FDI is just one of the many factors which needs to be looked at while creating a policy to boost the sector. To create such a conducive policy, the Government must focus on the larger picture, taking into account the best interests of all stakeholders. We need to think about the soldier on the border front, the business man making a huge investment, the Government and national interest, the security of every citizen. A pragmatic policy addressing the key concerns of each of these stakeholders is the need of the hour.
While the Government may not have met the expectations of global OEMs on the FDI cap, it has taken a bold decision to revoke FII ban for investing in the Indian Defence sector imposed by the previous regime.
As far as the taxation regime is concerned, today’s Budget failed to provide incentives to the sector from both direct as well as indirect tax perspective. The budget could have introduced more tax incentives for A&D manufacturing by bestowing “Infrastructure status” to the sector. There is tremendous scope to introduce much needed incentives in the direct tax regime governing the sector by introducing tax holidays and exemptions for companies undertaking manufacturing activities for example. Further, no significant headway has been made even on the indirect tax front. A reduction on indirect taxes on import of spares which is a pain area for the sector would have been much appreciated and could stimulate the MRO industry.
An overall assessment of today’s budget reveals that the suggested measures are disappointing considering the extent of changes that were expected at this juncture. The restrictive FDI cap and the absence of any significant tax benefits to catalyse in-country manufacturing is indeed a let-down. However, with Defence remaining within the Governments high-priority focus, one may hope that the Government’s on-going active management and fine tuning of policy, regulations, process and fiscal environment would help ensure  a conducive policy to spur domestic growth and self-sufficiency.

Budget 2014: Healthcare sector

Healthcare sector in India is witnessing growth at a rapid pace and is expected to grow at a CAGR of 15 per cent to touch US$ 158.2 billion in 2017.  The factors behind the growth of the sector are increasing population, rising income, growing lifestyle related health issue, easier access to high-quality healthcare facilities, improving health insurance penetration and greater awareness of personal health and hygiene.
Despite the tremendous growth potential, the sector is plagued with various challenges and issues. Expenditure on healthcare is just 1.4 % of India’s GDP. Further lack of basic infrastructure and non-fructification of Public Private Partnerships have adversely affected the healthcare space. High priority is required to be accorded to the health sector, which is crucial for securing the economy. The current situation calls for radical reforms in the healthcare system with regards to national healthcare programs and delivery, medical education and training and financing of healthcare. Industry expects key reforms such as grant of “infrastructure status” to the sector for availing profit-linked deduction, extending investment-linked deduction to smaller hospitals, maintenance of electronic health records, creation of exclusive dedicated Medical Technology Parks and tax incentives to spur R&D investment.
The policy measures and initiatives pronounced by the Finance Minister in the Budget fall in line with the overarching goal of India 'Health Assurance to all Indians and to reduce the out of pocket spending on health care'. Thus India is in need of a holistic care system that is universally accessible, affordable and effective and drastically reduces the out of pocket spending on health.
Policy measures in the Budget speech by Finance Minister

• Focus on ensuring that quality healthcare reaches every level of the demographic pyramid.
• Aim to address the infrastructure deficit (AIIMS in all States, 12 more medical colleges, dental facilities in all hospitals) and bridge rural –urban disparity (15 model rural health research centres).
• Focus on addressing the skill gap via the National Skilling Programme is commendable.
• Strengthening the States’ Drug Regulatory and Food Regulatory Systems by creating new drug testing laboratories.
• Focus on rural health issues by setting up Model Rural Health Research Centres.

In view of the strong growth prospects of the Indian healthcare industry and eagerness of foreign players for investment in India, the Government of India and the Ministry of Finance have initiated various measures for health sector. However, certain other expectations of the industry such as granting ‘infrastructure status’ to the sector, extensions of tax incentives for setting-up hospitals, incentives for domestic manufacturing of medical devices and consumables etc. have not been met. The Budget thus falls short of direct tax clarifications on the issues faced by the healthcare sector.

Budget 2014: Media and Entertainment Industry

Budget 2014: Media and Entertainment Industry
The Union Budget 2014 has been rolled out. Though not significant, a few policies impacting the sector both directly and indirectly have been announced.
Of the few measures announced for media and entertainment sector, most of them were directed towards the television sub-sector.

• The investment of INR 100 crore to launch a dedicated TV channel for real time information on various farming and agriculture issues will undoubtedly provide the much needed impetus for niche and specialty content. Another announcement to launch a 24X7 channel for the northeast region emphasizes the growing importance of localized content. Both these announcements will create significant opportunities for content providers, advertisers, and content repurposing companies (as a single channel for farmers across India with different languages and requirements might not suffice).
• The proposal to set up a national centre for excellence in animation, gaming and special effects, and accord the status of national importance to two premium film institutes – Film & Television Institute of India (FTII) and Satyajit Ray Film & Television Institute (SRFTI) – is another step by the government towards achieving a continuous flow of domestic talent, especially in the animation and VFX sector. The content development, production and post-production outsourcing activities will also gain momentum due to introduction of advanced learning programs and degree courses, and greater supply of skilled manpower.
• As digital media is one of the next growth drivers for the Indian media and entertainment industry, the government’s allocation of INR 500 crore for extending broadband connectivity to villages will broaden the reach of content providers and advertisers seeking opportunities to get their messages across to the masses.
• Liberalisation of FDI in e-Commerce sector is expected to indirectly boost the digital advertising revenue.
• The reduction in custom duty on 19 inch LCD and LED panels and below to zero from 10 percent will boost the sales of TV sets in the country, in turn propelling the growth of cable and satellite (C&S) subscribers.
• Sale of space or time for advertisements on various media other than print media has now been brought within the ambit of service tax. Previously, the sale of space or time for advertisements only on radio and television was subject to service tax. With the proposed amendments, service tax would now be applicable on the sale of space or time for advertisements on other segments such as online mobile advertising. Further, service tax would also be applicable on advertisements in internet websites, out-of-home media, on film screen in theatres, bill boards, conveyances, buildings, cell phones, ATMs, tickets, commercial publications, aerial advertising and the like.
• The Budget proposes to restrict the time within which cenvat credit can be taken by the service recipient. Earlier, there was no such restriction, but under the proposed amendments, cenvat credit on inputs and input services would have to be taken within a period of 6 months from the date of issue of invoice.
• However, the biggest dampener to the industry would be the lack of clarity on the GST implementation date. The industry was keenly seeking some clarity on the implementation of GST to give it some relief from the perils of multiple taxes faced by it.
• On the direct tax front the controversial retrospective amendments have not been withdrawn. Having said which, the Finance Minister has acknowledged that the sovereign right of the Government to undertake retrospective legislation has to be exercised with extreme caution and judiciousness. The Finance Minister has further assured that his Government will not ordinarily bring about any change retrospectively which creates a fresh liability.
• The budget proposes to extend Advance Ruling route even to resident taxpayers in respect of their income tax liability, but above a defined threshold.
• The budget proposes that dividends distributed by domestic companies and mutual funds are to be grossed up for the purpose of computing Dividend Distribution Tax. This would entail that the effective dividend distribution tax rate would go up by approx. 3%.
• The budget proposes to extend the benefit of lower rate of taxation on foreign sourced dividends without limiting it to a particular assessment year. Thus, such foreign dividends received during or on or after financial year 2014-15 shall continue to be taxed at the lower rate of 15%.
• On the transfer pricing front the budget introduces Roll back provision in Advance Pricing Agreement Scheme. The budget also seeks to introduce range concept, use of multi-year data for determination of ALP in accordance with best international practices.

The industry hopes for simplification of the onerous tax laws and resolution of some of the long standing issues impacting the sector have been dashed. There was no relief forthcoming from the Government, at a stage when companies were demanding reduction in custom duty on set-top boxes, rationalization of entertainment taxes, incentives for digitization, clarity on the process of license renewals, etc.  All in all the questions that have long troubled the industry still remain unanswered.
However, since there is a positive correlation between media and entertainment industry growth and GDP growth, the government’s aim to achieve 7-8 percent GDP growth in the next three-four years is a positive sign for the industry. 

() on \"A budget focused on tax stability and long-term growth\"
A budget focused on tax stability and long-term growth

Riding high on the resounding people’s mandate and saddled by the weight of expectations to reverse the slowdown in the economic growth, the FM presented the Union Budget 2014 before the Parliament on 10 July 2014. Tasked with the unenviable tightrope walk of augmenting tax revenues to achieve fiscal consolidation and providing tax breaks for simulating investments to propel growth, the FM has announced a slew of amendments to the Indian direct tax laws.
As all eyes were firmly set on the first budget to be presented by the new Government, a significant challenge before the Government was in the realm of taxation. Towards this end, one did expect quick steps to arrest concerns on account of rising tax litigations and repealing of the retrospective amendments. While there is no denying that repeal of the retroactive amendments was one of the biggest expectations from the Government, it may not be entirely fair to say that nothing has been done in this regard. A clear and unequivocal statement by the FM that no retrospective amendments will be ordinarily made is a clear sign of sending out signals to create a stable and predictable tax regime in India. Further, the proposal to refer all new cases relating to retro amendments on account of indirect transfer of assets to a High Level Committee before the Assessing officer initiates action on tax payer will definitely bring some quality to the tax proceedings at the grass roots level and prevent abuse of the law.
Towards this end, one of the most heartening features of the Budget 2014 has been the emphatic reiteration by the FM to provide certainty in the tax regime and reduce tax disputes. Recognising that the current alternate dispute redressal (ADR) mechanism pertaining to the Authority for Advance Rulings (AAR) is available only to certain specified taxpayers like non-residents and PSUs leading to large number of taxpayers falling outside the eligibility criteria, the FM has done well by announcing the expansion of the scope of the AARs to cover domestic transactions for both direct and in-direct taxes and to increase the capacity of the AAR with more number of benches to adjudicate the cases. Similarly, extension of one time Settlement Commission and the proposal to form a High Level Committee to interact with the Trade and Industry to address their tax issues are path breaking steps in this direction.
India Inc has other reasons to cheer as the Budget has proposed to provide significant tax relief to various other sectors of the industry. Recognising the potential of the manufacturing sector to drive growth and generate employment, investment allowance on investments in excess of Rs. 25 crores has been made available on investments in plant and machinery made during the period 1 April 2014 to 1 April 2017. This is likely to boost the SME capital investment in manufacturing by the SME sector and quicken the implementation of projects.  Similarly, considering the need to augment electricity generation capacity in the country, FM has also done well by extending the 10 year tax holiday for the power sector for projects commissioned till 31 March 2017. The power industry needs encouragement to invest large capital in setting up of power plants to ensure uninterrupted power supply and this move by FM is likely to boost the power sector, which forms the backbone of the economy. Proposal of restricting the disallowance to 30% of expenditure in cases of withholding tax default and introducing ranges, roll back of Advance Pricing Agreement (APA) and multiple year data in transfer pricing are very significant developments that will provide substantial relief to corporate tax payers.
Real Estate Investment Trusts (REITS) have been successfully used as instruments for pooling of investment in several countries. In line with this, the FM has done well by providing necessary incentives for REITS which will have pass through for the purpose of taxation. As an innovation, a modified REITS type structure for infrastructure projects has also been announced as Infrastructure Investment Trusts (InvITs), which would have a similar tax efficient pass through status, for PPP and other infrastructure projects. These structures are likely to reduce the pressure on the banking system while also making available fresh equity.
On the whole, Budget 2014 may be considered as a good first Budget for the NDA Government. It may not be a budget, which completely lives upto the heavy weight of all expectations, but it does seek to lay down directions for comprehensive growth amidst precarious financial position of the Government. It may be fair to say that Mr Jaitley’s first tight rope walk was reasonably well executed.

Budget Implications for the Infrastructure Sector

Finance Minister Shri Arun Jaitely presented his first Budget today in the Parliament. Overall, we believe that budget has been positive for the Infrastructure sector. The Budget provided a direction for resolution of some issues, laid down road map for long term development of key Infrastructure segments, especially the Rural, and Urban Infrastructure, and attempted to address some of specific sector issues around Power, Roads, Mining, Urban Transport, while providing a great fillip to Renewable Energy segment.
One of the key demand for sector have been an access to long tenure funds, and reduction of cost of financing. Banks have been encouraged to raise long tenure funds that will not be considered for SLR, and CRR requirements, thus reducing the costs to developers. Banks have been provided greater flexibility to structure the loans to Infra projects.  
The Budget highlighted the need to work on revival of stressed banking assets in Infrastructure which would ensure sector is not saddled with stranded projects. Infrastructure Investment Trust (IIT) structure to raise capital was extended to Infra projects with assurance to look into tax incentives pass through so as to avoid double taxation issues that were witnessed for Real Estate Investment Trust structures.
Institutional response in the form of creation of 3P India was provided for dispute, and commercial resolution of Infrastructure projects that we believe will go a long way to move the stalled projects
Investors were given assurance that mining issues shall be resolved even if it means revisiting the Act, which is an important statement of intent. All power projects that will come up or have come up by March 31, 2015 would be provided adequate coal. Rationalisation of coal linkages would ensure more coal availability as also substantial reduction in the logistics costs for Country (KPMG has estimated such savings to be about Rs. 5000 cr p.a few years back). 10 year tax holiday under 80 IA was extended till March 31, 2017 that will provide long term clarity for investment decisions as against the practice of yearly extension.
Given the long term Energy needs of the Country, clear focus on Renewable Energy, especially solar was heartening to note. Ultra Mega Sola Projects, focus on washed & crushed coal, looking at Ultra-modern supercritical technology based coal projects were very positive measures announced in the Budget. Renewed interest for Coal Based Methane projects is encouraging, however, that needs to be followed with implementation policy.
Impetus on a comprehensive Transportation policy that encourages multiple modes of transportation as required by Country was again a notable feature of the budget. Focus on rural roads, award of 16 new ports, increased outlay for NHAI, and state roads programme, setting of Expressways along the Industrial corridors, and creation of new airports would ensure hinterland connectivity, and linking of rural, and urban India. Thrust to have inland waterways projects as a means of transport was also highlighted with announcement of Ganga project. This comprehensive focus on transportation would over long period lead to more inclusive growth for the Country as whole
Intention to develop SEZs, and Industrial corridors was stressed with setting up of National Industrial Corridor HQ at Pune, and push to various other industrial corridor projects. Urban Infrastructure seems to be sitting at core of Government thought process with Rs. 50,000 cr outlay till March 2019, which is a good sign as that would spearhead number of small, but critical projects across cities, and urban local bodies. Intent for creation of smart cities was followed up with allocation of Rs. 7060 cr towards this initiative. This measure if implemented well will ensure creation of world class infrastructure as large part of the population gets urbanized.
This Budget is a good first step in a long journey of reforms that are required for the sector, and same needs to be followed up with clear measures. It attempts to address a number of issues that have been a problem for the sector, looks at long term planning for the sector as well. However, key would be in details of some of the measures announced, or policy intent, especially around resolution of stressed assets in banking system, and access of long tenure funds for the sector.

Tax on long-term capital gains on units - need & effects

Investments in Mutual Funds have always been an attractive source of investment for individuals. Until now, Long Term Capital Gains (LTCG) on units held in equity oriented fund and non-equity oriented fund have been subject to special tax regime i.e. concessional rate of tax.  The much awaited Union Budget 2014 has brought in a change which proposes to have an adverse direct impact on taxation of units held in non-equity oriented funds. This change will come into effect from 1 April 2014.
Under the existing income tax provisions, while the LTCG on units held in equity oriented funds are exempt from tax, LTCG on units held in non-equity oriented funds are subject to tax at the special rate of 20 percent with indexation benefit and 10 percent without considering indexation benefit.  This rate of tax is excluding education cess and surcharge (if applicable). Also, the period of holding for such units to qualify as long-term capital asset has been that such units (debt and equity) should be held for a period of more than 12 months.
In the Budget announced on 10 July 2014, the Finance Minister has proposed to a major change whereby, LTCGs on units held in non-equity oriented funds would attract a tax rate of 20 percent with indexation benefit.  The concessional tax rate of 10 percent is proposed to be withdrawn.  Also, the period of holding in respect of such units to qualify as long term capital asset is proposed to be increased from 12 months to 36 months. Accordingly, only if such units are sold post holding for a period more than 36 months, they would qualify to be treated as long term capital asset.  However, if such units are sold before 36 months of holding, the same would be considered as short term capital asset and taxed accordingly. 
Tax on Short Term Capital Gains (STCG) on units held in non-equity mutual funds would continue to be taxed at maximum marginal rate of tax as applicable to an individual.  However, with the proposed increase in the holding period from 12 months to 36 months, there would be an adverse impact on the individuals.
The illustrative taxation under current and proposed provisions have been tabulated below for ready reference:

*Surcharge @ 10% is payable if total income exceeds INR 1 Crore and Education cess is payable @ 3% on basic tax rate plus surcharge (if applicable).
** Transaction subject to Securities Transaction Tax (STT)
In early 2000, when the units were brought in the concessional tax regime, the objective was to promote retail investors to invest in such schemes.  It is understood that now in 2014, this change has primarily been proposed to bring parity in taxation of unlisted securities and units of non-equity funds vis-à-vis the Bank deposits and other debt instruments which currently attract tax at maximum marginal rate as applicable to the individual.  This change will take away the relative tax advantage envisaged by debt mutual funds over the traditional fixed income products.
These amendments will take effect in relation to the assessment year 2015-16 and subsequent assessment years.
Post the proposed change, long term capital assets being listed securities or Zero Coupon Bonds shall continue to be taxed at a concessional rate i.e. rate lower of the following:

• 10 percent of LTCG without indexing the cost of acquisition; and
• 20 percent of LTCG after indexing the cost of acquisition.

Also, the LTCG on units held in equity oriented funds would continue to be exempt from tax. 
Further, the period of holding of such assets to qualify as long term capital asset would continue to be 12 months or more.
In effect, the increase in LTCG tax on unlisted securities and units of non-equity funds such as fixed maturity plans, gold funds, etc. may have an adverse impact on the existing investors and also in future these schemes may become less attractive. The impact on existing and future investors is actually two fold, one on account of change in rate of tax and secondly by redefining the holding period from 12 months to 36 months.  However, if this change can bring in the expected substantial flow of funds to banking channels, it should give a boost to the Economy and contribute to promote a sustainable economy as envisaged by the Finance Minister.
Disclaimer:
The views and opinions herein are those of the author and do not necessarily represent the views and opinions of KPMG in India. All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.
 

Budget 2014 - Certain open & contradicting issues

The first budget of the new government is the topic of discussion these days and there is a debate as to whether the budget met with the expectations. It is rightly said that ‘devil is in the details’. One realizes a contradiction at least in the following two instances where what is spoken by the FM is dified in Finance Bill proposals:
 
1. Retrospective amendments
The FM speech at para 10 reads:
"....This government will not ordinarily bring about any change retrospectively which creates a fresh liability..."
However, there are a few direct tax proposals in the Finance Bill which have a retrospective effect and which creates fresh liability on the taxpayers:

• Amendment to section relating to deduction in respect of capital expenditure on specified business (section 35AD of the Income Tax Act, 1961)

It is proposed to insert a condition that assets on which investment linked deduction is claimed is used for purpose of special business for 8 years. If the condition is not met than the deduction originally allowed shall stand withdrawn.
The provision of Section 35AD was enacted in 2010. The user condition which is now imposed will operate on the assets which have been acquired any time between 2010 to 2014 and not used for 8 years.

• Amendment in the definition of short-term capital asset [Section 2(42A) of the Income Tax Act, 1961]

It is proposed to amend the definition of short-term capital asset so as to provide that an unlisted security and a unit of a mutual fund (other than an equity oriented mutual fund) need to be held for thirty-six months (as against twelve months) to qualify for the beneficial treatment of long-term capital gain. Thus, the amendment would be applicable for the transaction carried out between 1 April 2014 till now, creating fresh tax liability on the taxpayer.
 
2. Non-intrusive measures:
The FM speech at para 210 reads:
“210. The focus of any tax administration is to broaden the tax base. Our policy thrust is to adopt non intrusive methods to achieve this objective…..”
While the FM emphasized on non-intrusive measures, it provides for extending the powers of the tax authorities to survey in the matters of TDS and TCS related issues. To that extent there has been clear intrusive action proposed in the law for TDS/TCS matters, details of which can always be called by issue of notice.
 
Further, below are certain instances where the things are spoken on the floor of Parliament but the same has to see light of the day, either in terms of being implemented or being provided under the law:
 
1. Constitution of High Level Committee by CBDT to deal with issues arising out of retrospective amendment in 2012 for indirect transfer.
Para 10 of the FM speech reads:
“…..Keeping this in mind, we have decided that henceforth, all fresh cases arising out of the retrospective amendments of 2012 in respect of indirect transfers and coming to the notice of the Assessing Officers will be scrutinized by a High Level Committee to be constituted by the CBDT before any action is initiated in such cases….”
 
2. Extension of Advance Ruling facility to resident taxpayers.
Para 12 of FM speech reads:
“….Currently, an advance ruling can be obtained about the tax liability of a non-resident from the Authority for Advance Rulings…...I propose to enable resident taxpayers to obtain an advance ruling in respect of their income tax liability above a defined threshold….”
 
3. The proposal of enlarging the scope of Income-tax Commission so that the tax payers may approach the Commission for settlement of disputes.
Para 12 of FM speech reads:
“…..I further propose to enlarge the scope of the Income-tax Settlement Commission so that taxpayers may approach the Commission for settlement of disputes….”
 
4. Setting up a High Level Committee to interact with trade and industry on a regular basis and ascertain areas where clarity in tax laws is required.
Para 13 of FM speech reads:
“….I propose to set up a High Level Committee to interact with trade and industry on a regular basis and ascertain areas where clarity in tax laws is required…..”
 
5. Proposal to amend the Transfer Pricing regulations of India to reflect the following:

• introduce range concept in determining the arm's length price and
• allow use of multiple data for comparables.

Para 204 of FM speech reads:
“…...(2) In order to align Transfer Pricing regulations in India with the best available practices, I propose to introduce range concept for determination of arm’s length price……..
(3) As per existing provisions of Transfer Pricing Regulations, only one year data is allowed to be used for comparable analysis with some exception. I propose to amend the regulations to allow use of multiple year data…..”.
 
6. Review of Direct Tax Code.
Para 208 of FM speech reads;
“….The Government will also review the DTC in its present shape and take a view in the whole matter….”