Does it? Does it not? … Ever since the CBDT floated the idea of alternate Tax Accounting Standards, a ka the Income Computation and Disclosure Standards (ICDS), its applicability has been marred.  The first set of draft standards were published in 2012 (almost 6 years back) based on the recommendation of the CBDT appointed committee.  Industry and professionals, while agreeing with the desired intent for more certainty in tax, was up in arms (and rightly so) at the whole idea of a separate accounting language for tax purposes. 

The Government backtracked by toning down certain ICDS provisions as also deferring the applicability by 1 year form FY 15-16 to FY 16-17.  One thought that was the final nail in the coffin for the Industry's fight against the ICDS.  At almost the last moment when taxpayers were finalising tax audit and returns for FY 16-17 (AY 17-18), the Delhi HC ruled that the ICDS provision cannot apply to the extent they override judicial precedents in absence of a corresponding amendment of the Income tax Act (the Act). 

Finance Bill 2018 proposes two sets of amendments - Chapter IV-D (income from Business or Profession) and Section 145A-145B.  The primary intent seems to provide a legislative recognition to the ICDS provisions to the extent they were inconsistent with the basic provisions of the Act (as interpreted by the Courts).  Incidentally, no amendment has been made to the provision relating to computation of income from Other Sources, but that discussion for some other occasion.  Are these amendments now the final word on ICDS.  We discuss the same below. 

Retrospective effect (w.e.f. April 1, 2017)

The amendments would apply for computing income FY 2016-17 and onwards.  Several taxpayers had sought to rely upon the Delhi HC ruling and not carried out the adjustments required as per the ICDS provisions to the extent they were inconsistent with the Act / judicial precedents.  The proposed amendments would require taxpayers to file a revised return for AY 17-18 and recompute the taxable income now based on the applicable ICDS provisions. 

Contractor & service Income (section 43CB)

Section 43CB has been introduced to now mandate the profits and gains arising from a construction contract or a contract of providing services would be determined as per the percentage completion method as provided under ICDS-III and ICDS-IV, except in case of services contracts of tenure < 90 days or involving indeterminate acts over a specified period (like AMCs, etc).    

Firstly, the proposed amendments mandate that profits from services contracts of tenure < 90 days shall be computed as per the project completion method.  Now, for taxpayers who routinely enter into such contracts, generally make no bifurcation to ensure a uniform and consistent method of accounting revenues.  It would therefore have to be seen if such taxpayers can now compute income from all contracts (irrespective of tenure) as per the percentage completion method.   Interestingly, the exception is not sought to be applied to construction contracts and thus, such contracts (although for less than 90 days) would be required to be computed based on percentage completion method only. 

Secondly, it is provided that contract revenues includes Retention money.  While the ICDS too provides for the same, ultimately para 9 of ICDS-III provides that contract revenues (which includes retention money) shall be recognised only when there is reasonable certainty of its ultimate collection.  Thus, in case where the retention money collection cannot be established (having regard to the performance, etc., conditions of the contract) to be reasonably certain of collection, the same ought not to be still recognised as income even under the amended provisions.  Obviously, it would have to be consistent with the position taken thereon in the statutory books of the taxpayer.

Thirdly, incidental income like interest, dividend or capital gains is not to be deducted from the contract cost (and presumably offered to tax separately?).  This amendment would not apply to other receipts incidental to the contract / services like say recovery of rent form labourers, canteen recovery, etc. which were held as deductible by the Hon'ble SC in Bokaro Steel's case (236 ITR 315)

Lastly, it still needs to be evaluated whether the new section would apply to real estate developers.  As per the ICAI guidelines, a developer who has transferred all risks and rewards in relation to the property under a pre-sale to a buyer (customer), is considered as a contractor undertaking to construct the property for the said customer.  Nonetheless, Courts in India have permitted real estate developers to continue to follow the project completion method since the essence of their contract is not to construct the property but to sell it.  One would expect that position should not change under the proposed amendments. 

Forex MTM (section 43AA)

The new Section 43AA seeks to legislatively recognise the provisions of ICDS-VI dealing with forex fluctuation.  Interestingly, Section 43AA, unlike existing Section 43A (dealing with forex on capital assets purchased outside India on loan / deferred credit) does not contain a non-obstante clause.  It would thus apply that Section 43AA would be subject to other provisions of the Act, including Section 28 / 29 of the Act which have been interpreted to mean that the revenue profits / gains (as distinct from capital) should be subject to tax.  

Now, the Supreme Court in Tata Steel's case (221 ITR 285) has held that forex gain or loss on foreign loans / outstanding purchase price of fixed assets purchased from within India (which is not covered by Section 43A) would be on capital account.  As such, one would need to see if the new Section 43AA could apply in such cases, even though ICDS-VI does not recognise any such distinction. 

Other MTM / expected losses (Section 36(1)(xviii) read with Section 40A (13))

An immediate reaction on looking at the ICDS amendments suggests that non-recognition of “prudence” as a basic principle has not been specifically recognised in the law, and to that extent the Delhi HC ruling would prevail.  Possibly, the issue is to a large extent (if not fully) recognised that the amendments provide that non MTM / expected losses would be allowed unless permitted by the ICDS.  One would need to see if provision for doubtful debts / NPAs in case of banks and finance companies otherwise permitted under Section 36(1)(viia) / (viii) would stand the test of the new Section 40A(13). 

Subsidy (Section 145B(3))

The new provisions provide that the Subsidy income shall be taxed on receipt basis unless offered to tax earlier.  Now, certain capital subsidies were not subject to tax hitherto (based on court pronouncements) until the amendments made to Section 2(24)(xviii) of the Act.  One would expect that such subsidies accrued during the period prior to the said amendment should not be now subject to tax merely on receipt basis. 

IND-AS - the real elephant in the room

One larger disappointment with the Budget is the continuous lack of appreciation and clarity on the need for convergence of the tax rules with the new IFRS based IND-AS.  Clearly, the fair value principle embedded in the IND-AS leads to several open issues on the tax treatment of the relevant transactions.  While an attempt has been made to address them so far as MAT is concerned, the only option now in so far as normal tax computation is concerned is that the income shall have be recomputed having regard to the existing provisions of the Act read with the ICDS - which may necessitate maintenance of separate set of books in certain sectors like Infrastructure, financial services, leasing models, contract manufacturing, etc., and so on.  This remains the real big elephant in the room which no one is talking about. 

The article has been co-authored by Priya Narayanan(Director).

One of the most celebrated moments in the recent past has been India's ranking amongst nations for ease of doing business, published by the World Bank. For the first time, India's ranking moved up significantly by over 30 ranks to touch the 100^th. The rank is given based on an evaluation in a number of factors, including starting a business, dealing with construction permits, getting credit, etc. Couple of aspects that would be relevant from a non-resident standpoint is the rank on trading across borders and paying taxes. While there has been a marginal upward move in the rank on trading across borders, the jump on paying taxes is steep.

With the changes proposed in Budget 2018, has is become easier to business in India for the non-resident?  This article addresses the key changes for international taxpayers and the impact on the direct taxes front.

Aligning the definition of Business Connection under the domestic tax laws to that of Permanent Establishment under the treaty:

Business connection is a definition under the tax laws which brings to tax the profits of a non-resident for business activities undertaken in India. Under the Organisation for Economic Development's (OECD) Base Erosion and Profit Shifting (BEPS) project, countries have agreed to certain amendments to the tax treaties to tackle the issue of tax avoidance in an international trade context. These changes are effected in a single stroke under the Multilateral Convention (MLC) to which India is also a signatory.

One of the amendments which will be effected vide the MLC is that relating to the role of an agent. Where an agent plays a role in India acting on behalf of the non-resident, to what extent can a Permanent Establishment be triggered?

The amendment has been brought to widen the scope of the definition of “business connection” within the domestic tax laws. Earlier a situation where the Indian agent who habitually exercised an authority to conclude contracts on behalf of the non-resident, would trigger a business connection for the non-resident.

Now, an agent who habitually plays the principal role leading to conclusion of contracts by the non-resident and such contracts:

-      Are the in name of the non-resident; or

-      For the transfer of the ownership of, or for the granting of the right to use, property owned by that non-resident or that non-resident has the right to use; or

-      For the provision of services by the non-resident.

Let us study a case. An Indian sales agent of a non-resident supplier undertakes the following activities in India:

a)    Undertakes market research;

b)    Prepares a list of potential target customers;

c)    Identifies the specific targets and sets up meetings;

d)    Discuss product specifications with the target;

e)    Updates the non-resident supplier frequently with the updates;

f)    Sends a fee quote for the products to the target;

g)    Enters into negotiation with the target;

h)    Finalises sales price in consultation with non-resident supplier;

i)     Non-resident supplier signs of the contract.

In the list of activities given above, what constitutes an authority to conclude contract on behalf of the non-resident vis-à-vis plays a principal role in concluding the contract. Activities, which are listed in (a) and (b) may not even result in a conclusion of contract. However, activities listed in (c) to (i) could be regarded as playing a principal role in concluding the contract and thus trigger a business connection exposure. With the signing of MLI and a case where the counter party to the treaty has also accepted the revised definition, applying the treaty may not yield any favorable result for the taxpayer. 

Hence, the above change could have an impact for non-resident suppliers, service providers who sell their products, services through Indian resident agents. One may however note that the terms 'principal role', 'routinely concluded' and 'material modification' have not been defined and could, therefore, lead to different tests being applied by different taxing authorities. This will however be effective after the MLC comes into force. USA is yet to sign the MLI. On the other hand, Germany has signed the MLC but has not notified it to be applicable for treaty with India.

The amendment will come into force only once the MLC is passed by the Parliament. Till such time it is passed, the amendment will not be effective. Once passed, for countries where there is no tax treaty or the provisions of amended article is not notified by the other country partner under the MLC, then the broader definition under the domestic tax laws will come into play.

The amendment to the term business connection does not end there. Another change which widens the scope of the term “business connection” is the inclusion of “significant economic presence”. Where a non-resident has transactions in India irrespective whether it is in relation to goods, services, property or software/data download, and the transaction value exceeds the prescribed limit, then a business connection is triggered.

Taxation of income has been associated with a nexus based approach and the nexus used traditionally has always been physical presence. With the evolution of digital technology and its widespread footprint, physical presence is losing relevance in selling goods, services, property. Thus, the amendment seeks to bring to tax transaction that are executed even on a digital platform but the non-resident as such as no physical establishment in India.

The Government has also indicated that the threshold for revenue earned and the users in India will be decided after deliberation. Apart from online platforms that are registered overseas and sell goods, services software to Indian customer, even social networking platforms that collect huge amount of data based on the users registered will have to closely watch out. Even assuming a business connection under the domestic tax laws or permanent establishment under the revised clauses of treaty, attribution of income for the nexus with Indian users will be a challenge.

Amendment in capital gains tax regime

As a step towards eliminating tax arbitrage between investible asset-classes, the government has re-introduced long-term capital gains tax on equity shares. Equity asset-class has enjoyed tax-free status for more than a decade now. This parity among asset-classes has been introduced in stages. Firstly, in Budget 2017, the period of holding for real estate investment properties were reduced to 2 years (from 3 years) in order to qualify for long-term capital gains tax. Similarly, in Budget 2014, the period of holding for debt mutual funds was extended to 3 years from 1 year, bringing parity with bank fixed deposits.

From April 2018, long-term capital gains on equity will suffer tax of 10% without the benefit of indexation. The market-to-market gains on such shares up to 31-Jan-2018 will be exempt from tax, and the new cost base shall be the highest price of 31-Jan-2018.

In the case of a non-resident investors invested in these assets via Mauritius or Singapore, grandfathering for investments made prior to 1 April 2017 can be availed under the respective tax treaties. Further, a beneficial capital gains tax rate of 50% of the domestic capital gains tax rate will be available during the transition period from 1 April 2017 to 31 March 2019. These beneficial provisions are however subject to certain conditions prescribed under the respective treaties.

Requirement to obtain a Permanent Account Number for the non-resident tax payers and its principal officers

A non-resident is subject to tax in India only in respect of taxable income. Further, only if there is a taxable income and consequently a requirement to file a tax return the need to obtain a unique identification number (Permanent Account Number). However with the proposed amendment, any tax resident (other than an individual) who enters into a financial transaction of an amount aggregating to INR 250,000 or more will be required to obtain a PAN.

It is also interesting to note that in case of companies, the managing director, director, CEO or principal officer of such a company is also required to obtain a PAN.

This proposal could bring undue hardship to non-residents who transact with Indian customers and do not earn a taxable income in India (for example, offshore supply of goods with no permanent establishment in India). Strangely, the officers of such company will also be required to obtain a PAN registration in India.

Prosecution proceedings for non-filing of returns

Currently, prosecution proceedings for failure to file tax returns is not triggered in case the outstanding tax liability is less than INR 3,000. In order to prevent abuse by shell companies, there is proposal to do away with this threshold for all companies. Thus, in the case of any company that does not have an outstanding tax liability, but fails to file a tax return, then the principal officer of such company can be liable to prosecution.

It is pertinent to note that this definition can extend to non-resident taxpayers as well since the definition of the term company includes foreign companies.

For example, a foreign company earns royalty or fees for technical services from an Indian tax resident. The Indian resident withholds the taxes and the non-resident has no further tax liability in India. Earlier, in this scenario if the non-resident does not file a tax return disclosing the income, a prosecution could not be initiated. However, under the revised rules, failure to furnish a tax return could lead to a prosecution trigger for the principal officer of the non-resident company. 

The Finance Bill 2018 introduced in the Parliament has proposed following amendments in respect of dividend under the provisions of Section 2(22) as follows. -

Widening the scope of meaning of Accumulated Profits for the purpose of dividend

The taxability of dividend under the deeming provisions of Section 2(22) (d) and (e) has remained mired in controversy and litigation.

Section 2 (22) defines dividend to include distribution of accumulated profits (whether capitalised or not) by a company to its shareholders if it entails

(a)    a) release of part of all or any part of its assets

(b)   b) issue of debentures in any form (with or without interest) and any distribution of bonus to the preference shareholders

(c)    c) distribution to the shareholders on its liquidation

(d)   d) distribution on reduction of share capital to the extent of the accumulated profits

(e)    e)  payment by a closely held company of any sum by way of advance or loan to a shareholder who is the beneficial owner of shares (not entitled to fixed rate of dividend and whether with or without right to participate in profits) holding not less than ten per cent of the voting power or to any concern in which such shareholder is a member or partner and in which he has a substantial interest ( exceeding 20% of shareholding or interest) or any payment by such company on behalf of or for the individual benefit of any such shareholder

Explanation 2 to the said section defines accumulated profits to mean all profits upto date of distribution, or payment or liquidation subject to certain conditions.

Spur in corporate restructuring activity e.g. mergers and acquisition has led to different modes of capital restructuring including buy back and capital reduction and litigation has ensued as a consequence on the tax implications of such transactions with reference to the said provisions of Section 2 (22).

Reference is imperative at this juncture to the decision of Honourable Bombay High Court in the case of Capgemini India Private Limited (Company Scheme Petition No.434 of 2014 dated 28.04.2015) wherein the Court had to deal with the schemes of buyback of shares and reduction of capital under Companies Act. Honourable Bombay High Court held that it is open to a company to buy back its own shares by following the procedure prescribed under section 77A/Section 68 or by following the procedure prescribed under section 391 read with Sections 100 to 104 of the 1956, of the Companies Act. The observations of the Hon'ble Court clearly reckoned the distinction between the buyback of shares and reduction of capital under the Companies Act.

Honourable Mumbai Tribunal in the case of Goldman Sachs (India) Securities Pvt. Ltd vs. ITO (70 taxmann.com 46) referring to the said observations of Bombay High Court held that 2(22) (d) (iv) r.w.s.46A of the Act would be applicable to the buyback scheme and not to reduction of capital.

Honourable Mumbai Tribunal went on to hold that transaction of buy back of shares which had taken place prior to insertion of Section 115QA was not taxable as deemed dividend. Section 115QA was introduced with effect from 1^st April, 2013 under Chapter XII-DA titled Special Provisions relating to tax on distributed income of domestic company for buy back of shares.

In the scheme of amalgamation, Companies with large accumulated profits have resorted to the use of the accumulated profits of amalgamating company to reduce capital and avoid payment of tax on the distributed profits by remaining out of the clutches of the provisions of sub clause (d) of Section 2(22).

To overcome such a practice and ensure payment of tax on the distributed profits, explanation 2A in clause 22 of Section 2 is proposed to be introduced to provide that in the case of an amalgamated company accumulated profits whether capitalised or not or accumulated losses shall be increased by the accumulated profits of the amalgamating company on the date of amalgamation whether capitalised or not. The amendment aims to widen the scope of definition of accumulated profits for the purpose of dividend. The amendment is proposed to be effective from the A.Y. 2018-19.

Application of Dividend Distribution Tax (DDT) to deemed dividend

The characterisation of payment of loan/advance by a closely held company to a shareholder as deemed dividend contemplated under clause (e) of Section 2 (22) and attracting tax thereon has also been a subject matter of extensive litigation.

With a view to bring the curtains down, the CBDT came out with a Circular No. 19/2017 dated 12^th  June, 2017 on the said issue of payment of trade advances.

The Board inter alia observed that Courts in the recent past had consistently held that trade advances in the nature of commercial transactions would not fall within the ambit of the provisions of section 2(22)(e) and such views have attained finality. The CBDT inter alia noted some illustrations/examples of trade advances/commercial transactions held to be not covered under section 2(22)(e) of the Act and referred to the decisions in CIT vs. Creative Dyeing & Printing Pvt. Ltd., Delhi High Court  (318 ITR 476), CIT vs Amrik Singh, Punjab & Haryana High Court (231 Taxman 731) and CIT Agra vs Atul Engineering Udyog, Allahabad High Court (228 Taxman 295). The CBDT also acknowledged that in view of the settled position that trade advances, which are in the nature of commercial transactions would not fall within the ambit of the word 'advance' in section 2(22) (e) of the Act, appeals would not be filed henceforth on this ground by the Department and those already filed, in Courts /Tribunals may be withdrawn/not pressed upon. The Revenue however was deprived of the tax on deemed dividend in situations where advance/ loan which was not genuine trade advance was camouflaged as trade advance.

Another bone of contention has been the interpretation of expressions shareholder having substantial interest and beneficial owner of share employed in the clause (e) of Section 2 (22). The said terms have time and again fallen for interpretation and consideration of High Courts and Supreme Court.

Recent decisions of Honourable Supreme Court in the case of Gopal & Sons (HUF) reported in 391 ITR 1, Madhur Housing and Development Company (Appeal no. 3961 of 2013) and decision in National Travel Services C.A. NO. 837 of 2018 @ S.L.P. (C) NO. 27245 OF 2017 requesting constitution of a larger bench bear testimony. The last word has remained elusive and is yet to be pronounced.

The certainty and clarity leading to collection of tax from the payee of the deemed dividend has been adversely affected in such circumstances.

Amendment is now proposed as a remedial measure to omit the explanation after Section 115Q in Chapter XII-D and bring the deemed dividend under the regime of Dividend Distribution Tax under provisions of Section 115O. The onus of payment of tax has thus shifted on to the payer. The issue of genuine trade advances has not got addressed and an amendment to exclude the genuine trade advances from the ambit of clause (e) of Section 2 (22) could have brought in the required clarity and completeness.

The deemed dividend is proposed to be taxed at 30% (without grossing up). The amendment is proposed to be applicable to transactions referred to in clause (e) of Section 2 (22) undertaken on or after 1^st April, 2018.
 

Both the proposed amendments are in step with the Government's avowed objective of widening and deepening the tax base and rationalisation of tax provisions to bring in needed clarity and certainty.

Introduction

There have been attempts world-wide to bring to tax stateless income, especially in the digital economy. BEPS Report on Action 1 deals with issues in digital economy that consists of artificial arrangements as well as broader tax challenges from digital economy. The broader challenges include the non-applicability of a physical presence based tax nexus on digital businesses, characterization of income and valuation of user data and contribution. Though the BEPS project gave the pride of place to the issues arising out of the digital economy as Action 1, consensus has eluded the participating countries on how to prevent base erosion and profit shifting in the digital economy and the Report recognised that further follow-up work may need to be done. The Report set a deadline for producing an update by 2020.

In the meanwhile, CBDT commissioned a Committee on Taxation of eCommerce to come up with solutions. This eCommerce Task Force in its Report recommended the imposition of equalisation levy on various activities and services. India chose to act alone and introduced equalisation levy vide Finance Act, 2016, albeit on a limited number of services.  

The concept of “significant economic presence”

The Finance Bill, 2018 seeks to introduce the concept of “significant economic presence”. The proposed Explanation 2A to section 9(1)(i) of the Income-tax Act, 1961 (the “Act”) seeks to include such presence of a non-resident in India as a business connection referred to in section 9(1)(i), which would lead to income being attributed to income-tax in India. The two clauses of this new Explanation 2A are discussed below.

Transaction in respect of goods, services or property

As per clause (a) of Explanation 2A, a transaction in goods, services or property  carried out by a non-resident in India leads to a ”significant economic presence”. A wide interpretation that covers cases of transactions in tangible goods seems incongruous. This is because this explanation seeks to bring into the meaning of the term “business connection” and tax something which is already not subject to inclusion in the scope of income. A transaction of tangible goods if carried out in India could actually accrue or arise in India and there would be no need to provide for the same through this new Explanation.

The Explanatory Memorandum refers to the BEPS Action 1 Report on Digital Economy and also refers to the intention to bring emerging business models, such as digitized businesses which do not require physical presence of the non-resident or his agent, within the scope of “business connection”  under section 9(1)(i) of the Act. Accordingly, it is necessary to restrict the transactions in goods, property or services to those which are delivered digitally while interpreting this clause. A suitable amendment to the proposed Explanation would lay the matter to rest.

Further, this clause includes in its ambit “provision of download or data or software”. The 'transfer right for use or right to use a computer software' is covered under clause (vi) of section 9(1) of the Act. Since clause (vi) is more specific, it should override clause (i). However, it may be noted that the term 'software' in the proposed clause is not limited to computer software.. Also, the term 'data' is not defined and could get extended to include any information on the Web, so long as that is the subject matter of the transaction. Further, the transactions covered under this sub-clause could be both B2B and B2C.

Soliciting of Business activities and user interaction

A closer reading of the phrase “systematic and continuous soliciting of business activities” reveals that what is sought to be brought into as a business connection is the soliciting of business activities and not the activities of soliciting business.  Thus, only B2B activities could get covered under this phrase and not B2C activities. For instance, any marketing done to a consumer not in business herself would get excluded. The clause may be better worded if the intention was to cover marketing activities.

The later part in clause (b) refers to 'engaging in user interaction' which is sought to be used as a proxy to determine whether there is a significant business being conducted by the non-resident in India through digital means.  However, the term 'interaction' is not defined.

In this context, it is useful to understand the nature of digital business from the perspective of how users interact with websites. These could be sliced broadly into three types: The first is where the business is done actively with the non-resident entering into contracts with customers with digital files being transmitted over the internet. The second is where the users exchange information with the website. Not every exchange of information could lead to a business presence of the non-resident in India. In this scenario the level of interactivity and the extent of commercial nature of the information exchanged should determine whether the non-resident has sufficient significant presence in India so as to warrant imposition of income-tax.

The third category is the websites which merely provide information to the user but are otherwise passive. It would be difficult to hold non-resident owners of such websites to have significant business presence in India even if such websites provide information asked for by the users. Cases where the user is limited to only registering herself on the website or give her feedback should not breach the threshold of “interaction” required under the proposed Explanation. Conceptually, such a website only offers its goods or services on the internet without any sale or delivery.

The threshold for creating business connection is the number of users which is to be prescribed. In digital business, the users are fluid and mobile. Businesses often include anyone who has logged in to their site in their count of “users” to get better business valuations though these one-time users may not lead to any revenue or income. There is a need to limit this threshold only to active users to avoid labelling a non-resident's digital business as having a significant economic presence.

Attribution

The second proviso to Explanation 2A requires attribution of income based on the transactions carried out or the activities engaged by the non-resident.  As discussed earlier, a prescribed number of users is a threshold for significant economic presence.

The eCommerce Task Force recognised that users are “a significant indicator of both nexus and creation of value in the jurisdiction of source” due to their role and contribution by way of data, content creation and networking benefits. However, the Task Force recognised the difficulty in quantifying such value creation which was one of the principal reasons for the introduction of the equalisation levy.

When there is so much difficulty in determining whether a user contributes to a business presence in India of a non-resident, use of such users to attribute income is on shaky foundation.

Equalisation levy interplay

Equalisation levy is on the amount of consideration for any specified service received or receivable by a person, being a non-resident from a person resident in India and carrying on business or profession or from a non-resident having a permanent establishment in India.  The term “specified service” means online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement. The term "online" means a facility or service or right or benefit or access that is obtained through the internet or any other form of digital or telecommunication network.

Any income which is subject to equalisation levy is exempt from inclusion in the total income under section 10(50) of the Act. This is even if the non-resident has a significant business presence in India. To avoid taxing the same income twice, the users related to the specified services for the purposes of equalisation levy ought to be excluded from the threshold of the number of users while determining “significant economic presence” as well as for attributing income thereafter.

Conclusion

Instead of expanding the scope of specified services that attract equalisation levy, the Government has chosen to widen the term 'business connection' by introducing the concept of 'significant economic presence' (as against the existing 'physical presence') required to subject income of the non-resident to tax in India. It is probable that the Government expects this concept to play a lead role in the soon to be released report of the OECD on Digital Economy and expects international consensus on the same and lead to amendment of the double tax treaties in the foreseeable future. However, the new explanation requires further elucidation of the terms used therein and the scope of what it seeks to cover. That will bring certainty to the taxpayer of what is to be taxed in India.

The Finance Bill 2018 has proposed for amendment in Section 139A of the Income Tax Act 1961 for enlarging scope for circumstances under which every should apply for Permanent Account Number ('PAN') in India.

The existing provisions of Section 139A mandates application for PAN to be made only in cases where;

1)      Total Income of any person during the particular year exceeds the maximum amount not chargeable to tax; or

2)      Such person is carrying on business or profession in which total sales or turnover or gross receipts are likely to exceed Rs 5 lakhs in any particular year; or

3)      Such person is required to furnish return of income under section 139(4A) of the Act.

The word person as given in section 139A is defined under section 2(31) of the Income Tax Act which includes an Individual, a Hindu Undivided Family (HUF), a company, a firm, an association of persons or local authority and every artificial juridical person.

Also, the maximum amount not chargeable to tax has been provided for in case of Individual, association of persons, HUF which provides for Rs. 2,50,000 only. The said maximum amount not chargeable to tax represents the amount of income and not amount of receipt / transaction.

Section 139(4A) provides for mandatory filing of return of income by Charitable or Religious Institutions which has earned income exceeding maximum amount not chargeable to tax i.e Rs. 2,50,000

The Finance Bill 2018 has proposed to introduce two more sub-clauses in sub-section (1) of section 139A of the Act which provides as under:

139A(1) Every Person,

(i)….

……

(v) not being an individual, which enters into a financial transaction of an amount aggregating to two lakh fifty thousand rupees or more in a financial year; or

(vi) who is the managing director, director, partner, trustee, author, founder, karta, chief executive officer, principal officer or office bearer of the person referred to in clause (v) or any person competent to act on behalf of the person referred to in clause (v)

It is proposed that every non-corporate entity in any form in India should apply for PAN where it enters into financial transaction of aggregate value of Rs 2,50,000 or more in any financial year. Thus, the important observation is regarding the threshold kept for non-corporate entities which is linked to transaction value unlike value of income as provided in clause (i) of Subsection (1) of Section 139A of the Act.

Similarly, every natural person who are managing director, director, partner, trustee, author, founder, karta, chief executive officer, principal officer or the office bearer of above non-corporate entity (hereinafter referred as 'associated natural persons') should also mandatory apply for obtaining PAN in India. It should be noted that no value-based threshold is applicable either for income or for transaction value under such circumstances. Every such associated natural person should mandatory apply to the assessing officer for PAN even though income in their hands does not exceed maximum amount not chargeable to tax (Rs. 2,50,000) or value of financial transaction does not exceed Rs. 2,50,000 in any financial year.

This amendment will take into effect from 1^st April 2018.

Ease of doing business vs. Measures to tax evasion by widening tax base in India

Generally, the directors of foreign company registered in India generally do not apply for PAN in India since they do not have income chargeable to tax in India which exceeds the maximum amount not chargeable to tax as given in Chapter II of Finance Bill. (Rs. 2,50,000). However, considering the above amendment, it is proposed that every associated natural person of such foreign company should apply for PAN in India. The proposed amendment makes every person who holds capacity in form of managing director, director, , chief executive officer, principal officer or the office bearer of such foreign company, makes mandatory to apply for PAN in India.

The fifth clause of sub-section (1) of section 139A also proposed for making mandatory for every principal officer of the non-corporate entity to obtain PAN in India. The word principal officer is defined under section 2(35) of the Act which includes the secretary, treasurer, manager or the agent of the company. The proposed amendment in section 139A enlarges scope of mandatory application for obtaining PAN in case of persons associated with non-corporate entities in India. It is observed from above definition of principle officer that every person who is holding position in capacity of 'manager' in every non-corporate entity should required to obtain PAN even when his / her income does not exceed the maximum amount not chargeable to tax in India.

Both the above circumstances suggest government's intention of widening and deepening tax base in India. However, at the same time, it makes cumbersome compliance process for the foreign enterprise to enter Indian business market. Considering requirement of time for the existing government to curb circumstances of creating black money in market, the proposed amendment also creates some difficulties for foreign as well as Indian business players. The one of the objective of existing government is to implement ease-of-doing business in India. At the same time, the government must introduce measures like above to curb the tax evasion being part of its commitment to make India corruption free. This clearly shows the balancing the two wheels of Indian nation by the government by implementing ease-of-doing measures with introduction of measures to avoid tax evasion at the same time.

Redundancy of Section 206AA

The Finance Act 2010 had introduced the provisions of section 206AA of the Income Tax Act which provides for withholding of tax at higher rate in case where person receiving payments fails to furnish PAN. Such provisions were relaxed in case of non-residents in respect of payment in the nature of interest, royalty, fees for technical services, and payments on transfer of any capital asset, if the such non-resident furnishes certain details and documents as specified in Rule 37BC of the Income Tax Rules 1962, as introduced by Finance Act 2016.

The proposed amendment under section 139A in Finance Bill 2018 makes the provisions of section 206AA redundant to the extent where the financial transaction value exceeds Rs 2,50,000 in cases where the transactions are of nature specified in Rule 37BC of the Income Tax Rules, 1962. Now, the amended provisions of section 139A makes mandatory application of PAN for all entities entering into financial transaction of Rs 2,50,000 or more in financial year. In the circumstance where higher rate of withholding of tax is applied by the any entity by complying the provision of section 206AA of the Act, at the same time it will attract penal consequences of non-application of PAN under section 272B of the Act.

Rational

The memorandum explaining Finance Bills 2018 also provides that the main purpose of above proposed amendment is to use PAN as Unique Enterprise Number (UEN) for non-individual entities. It also explains that to link financial transactions with natural persons, it is proposed for mandatory obtaining of PAN by the associated natural persons of such entities.

The government of India through its National Policy for Skill Development and Entrepreneurship 2015 has proposed for introduction of Unique Enterprise Number (UEN) which will new enterprise shall use for various registration purposes including taxes, labour laws and social security. Once UEN is available all regulatory and support agencies shall use it to fasten the process of setting up and enterprise.

Every entity in India currently has multiple numbers that include Labour Identification Number (LIN)/Shram Pehchaan Sankhya (SPS), Corporate Identity Number from ROC, PAN Number, GST Number, Profession tax number, ESIC Number, Import Export Code etc. It has been proposed by the Ministry of Skill development and Entrepreneurship that adopting PAN number as the UEN rather than creating a new series is logical because it is already used for Income Tax, Customs, Excise and Service Tax.  Adopting PAN has many advantages; it allows all kinds of entities to obtain a number, the technology is already tested and in place, it allows for the Aadhar linking of office bearers, it is already used by a large number of entities, it will not require any change in banking or tax systems, it will not require a new law to govern the issuance authority, and it does not require a new authority to host the UEN and run the system. Considering the above proposed plan under National Policy for Skill Development and Entrepreneurship 2015, the Finance Bill 2018 seeks to amend the provisions of section 139A to align the UEN to each entity in India.

The article has been co-authored by Deepa Dalal (Partner, Tax - Mergers & Acquisition). 

We have overcome the seven year itch but are now stuck with the return of a fourteen-year predicament! Over the past fourteen years we had got used to easily buying and selling or transferring equity shares on the market, whether it was group reorganization or a family settlement or an on-market sale, to monetise investments. Needless to say, all this was from a long term perspective.

Going back in time, in 2004, we were conditioned to pay tax on transactions - replacing long-term capital gains tax - for easier collection. We agreed with the statistics and moved on to paying transaction tax irrespective of profits or losses. Now, as the statistics may make sense, we are going to pay both.

Refreshing some memories, last year we witnessed the change which taxed any movement of listed shares with lower than fair value, being brought into tax net at the full rate. This change was largely represented to be withdrawn as these were mostly scenarios where no economic benefit was sought to be derived and law had earlier provided exemptions to such transfers under the capital gains tax provisions and even grandfathered costs in certain examples.

Also, last year, in one of the many impactful speeches - there was the indication of a hint to withdraw the exemption; but everyone heaved a sigh of relief when the same took shape of just pruning the exemption to acquisitions without Securities Transaction Tax (STT). We saw a list of genuine transactions being kept out of this requirement to pay STT which was much appreciated.

Let's now dive into what is in store from April 1, 2018. So, in order to avail the “beneficial” rate of tax of 10%, there should be a payment of STT. A notification is awaited to specify cases where the condition of payment of STT will be relaxed, like we saw last year. However, we will have to wait and watch to see the results of all the representations to be made on the clarificatory notification. Let us hastily add the good part - a step of cost basis to the maximum price of listed share on January 31, 2018, (the markets have been going northwards and we are not complaining about the choice of the date) is provided in line with the promise of not effecting retrospective amendments. This grandfathering was indeed welcome! Due to technical reading of provisions for FII investors, the step-up seem to be unintentionally missed out. We saw quickly a clarification to include the step-up provisions for them as well.   

This makes us wonder about the long term transactions that will fall in the tax net. India Inc witnessed highest buybacks ever in the last two years. These were again exempt from taxes, if held as long term, since the buybacks were effected through the stock exchange and a benefit of the exemption could be claimed. Now, the buybacks will also be subject to the 10% tax on long term capital assets. Stakeholders will re-evaluate the positions, basis the math. Another one to be considered is off-market transactions which may not be at prevailing at market prices. The question is whether 20% tax with indexation benefit versus 10% tax with no other benefit, is better. The answer to this will need to be evaluated on a case-to-case basis. One important point is that there is already a provision which permits shareholders of listed securities to exercise a choice between 20% tax with indexation benefit and 10% tax without indexation benefit. The newly introduced section allows the 10% rate plus a few other benefits like grandfathering and exemption of 1 lakh, subject to STT payment.

In case the intention is to not transfer it at listed price due to negotiation or other considerations, it will still be possible to do an off-market transaction. Needless to say gift tax provisions still prevail and one needs to examine best possible mechanism to transfer where economic consideration is not really the one driving the transaction - such as gift / restructuring within the group. In such cases General Anti Avoidance Rules will also have to be tested.

However, apart from the transactions being notified (like last year when the notification relating to the proviso to Section 10(38) was announced) this time around even the computational aspects would play a pivotal role.

The newly inserted section 112A talks about Fair Market Value of such assets to be deemed cost. The term 'Fair Market Value' has been defined to be, in case of a listed capital asset, the highest price of the capital asset, quoted on the stock exchange on January 31, 2018, or any preceding date (if no trading of such asset took place on January 31, 2018), when the trading took place.

The issues that arise here are from computation of gains for listed shares to be sold on or after April 01, 2018. Let's look at a scenario of an unlisted company which would go for listing post January 31, 2018. The shareholders of such a company, if they were to sell shares of the company on or after April 01, 2018, post its listing it would not be covered under the new section unless such a situation is specifically exempted under the notification in respect of STT payment at the time of acquisition. In such a case, one can say the determination of “cost” to be deducted from sales consideration while computing capital gains is not possible and therefore applying the rationale of Supreme Court's decision in case of B. C. Srinivasa Setty (128 ITR 294), the computation mechanism fails and hence the sale consideration cannot be subject to tax. This is more so since in case of unlisted capital asset being a unit there is a cost determination as on January 31, 2018, by applying the net asset value of such unit; but the same is not currently provided for shares.

Similar complex issues arise in case of shares held in listed / unlisted company which undergoes a merger / demerger post January 31, 2018. As the grandfathering for value as on January 31, 2018, ideally should apply basis holding of shares in amalgamating / demerged company, however a specific provision will be required to address the issue. In case of a company undergoing a split of shares or consolidation as well, the grandfathering of cost will need to be addressed. Thankfully, the stepping up of cost basis for rights and bonus issue between April 1, 2001 and January 31, 2018 are covered in the latest FAQs on this subject.

For all those who have held securities indeed as long term and continue to hold as such, are still unsure whether in the long term the grandfathering (as on January 31, 2018) be of any good? In other words, they are simply hoping that the market does so well and significantly grow from January 31, 2018 onwards, that the new levy is palatable. So as they say - the interests of the common man and the tax man may see a meeting point! Both will be happy if the markets move northwards. Well, we indeed are seeing some nation building jointly happening soon towards a larger growth.

The article has been co-authoered by Vignesh Krishnaswamy, Chartered Accountant. 

1              Objective

1.1     One of the most controversial amendment, in this budget has been the introduction of tax on long term capital gains arising from listed shares, unit of an equity-oriented fund, etc. There have been quite of a few basic material made available on public domain as far as this provision (section 112A) is concerned, highlighting the method of computation of taxes. In this article we seek to highlight certain issues which may arise as a consequence to introduction of this section viz., the impact of existing provisions under the Income tax Act, 1961 ('ITA'). Coverage of relevant portions of the latest FAQ[1] released by the CBDT has also been made.

1.2     Withdrawal of exemption and bring into the tax net Long-term Capital Gains ('LTCG') of listed shares and other assets in the current budget comes no surprise to the professional fraternity, as it has been lingering in the air for last few weeks even prior to the budget presentation by the Finance Minister. In this background, it is always important for us to understand the background for introduction of a new provision before we deliberate further. The rationale behind the taxation of LTCG from sale of equity shares of a company or a unit of equity-oriented fund or a unit of business trusts (for the purpose of this article referred to as “specified assets”) as captured in the Memorandum to the Finance Bill are as follows:

1.       The current exemption scheme being inherently biased against manufacturing and has encouraged diversion of investment in financial assets;

2.       Significant erosion in the tax base resulting in revenue loss;

3.       Abusive use of tax arbitrage opportunities created by the exemption under section 10(38).

2              Overview of section112A

2.1          Relevance of chapter head

Section 112A, is introduced as part of Chapter XII “Determination of tax in certain cases” and starts with a non-obstante clause, being restrictive to the extent of section 112 only. Therefore, this provision is only a machinery provision for computing tax in a manner laid out under section 112A on such LTCG arising from sale of LTCG. It would be interesting to see in the later part of the article how this can lead to a unintended legislative lapse in introducing the provision leading to unanticipated benefit to the assessees. 

2.2          [2]Conditions to fall under section 112A 

Further, it is important to see the types of assets covered under the tax net for the purpose of section 112A. The specified assets being equity share of a company, a unit of an equity-oriented fund or an unit of a business fund.

Now, under what circumstance or fulfilment of certain conditions should this provision be applicable?

Tax under section 112A shall be liable on such LTCG, which satisfies the following conditions:

i.             Total income includes income under the head “capital gains”;

ii.            Capital gain arises from long term capital asset being specified assets;

iii.          Security Transaction Tax ('STT') to have been paid for:

a.    an equity shares of a company, both at the time of purchase and sale;

b.    unit of an equity-oriented fund or a unit of a business trust, it is sufficient if STT is paid at the time of sale.

The conditions are to be simultaneously satisfied.  Once the conditions stated above are satisfied, it is mandated that the computation of taxes are to be made in accordance with this section. However chargeability[3] shall still be governed as per section 2(47) of the ITA.

As per the FAQ[4] released, the CBDT suggests that calculation is to be made by deducting the Cost of Acquisition from the Full Value Consideration. Though in our view this may only be restricted to the determination of taxes.

2.3          Computation of tax

Gains arising on sale of such long term capital assets, tax is payable (i) at the rate of 10%, (ii) on the long-term capital gains of exceeding Rs. 1,00,000.

Further in computing the taxes for such long term gains section 112A provides, provisio one and two of section 48 shall not apply (includes denial of indexation to cost of acquisition for long term capital asset).

In order to grandfather the gains until 31 January 2018, the provision deems to provide the cost of acquisition in the following manner to extend the benefit the FMV as on 31 January 2018 to the assessees. According to sub-section (6) the cost of acquisition shall have to be deemed in the following manner:

• In case of specified assets having been purchased before 1 February 2018, the cost of acquisition shall be as follows:
• Manner of arriving at cost shall be, higher of (i) or (ii):

(i) the actual cost of acquisition of such asset; and

(ii) the lower of—

(a) the fair market value of ('FMV')[5] such asset; and

(b) the full value of consideration ('FVC') received or accruing as a result of the transfer.

To this extent, it appears the legislature has envisaged this to be a separate mechanism for the purpose of arriving at the cost of specified assets under section 112A in so far as computation of taxes. It is a settled position un law that where a deeming fiction cannot be extended beyond its scope. Therefore, cost being deemed for the purpose of section 112A cannot be extended to any other provisions under the ITA, except for section 112 in computing the capital gains.

Now take an illustration to understand the effect of the deed cost in computing the gains on sale of equity share of a company for the purpose of section 112A:

Tax rate of 10% shall be applied on such gains, after giving effect to basic exemption limit and chapter VIA deduction.

It may also be very interesting to see from the Memorandum[6] explaining the Finance Bill, 2017 under para II to the heading “A. Rates of Income Tax” under “Direct Taxes” that in heading that tax under section 112A shall be a tax to be deducted at source. However, nothing in the bill seem provide for a corresponding section in Chapter XVII of the ITA.

In the FAQ released, it has been clarified[7] that no tax deduction shall be required in case the payment of long term gains is made to a resident. In case of non-residents (other than FIIs) shall still be subject to tax deduction at source ordinarily under section 195, at 10% as specified under the new provision. 

3              Issues in computation of LTCG

3.1    Sub-section (5) of section 112A provides the following in respect of computation of capital gains under this section:

“(5) The capital gains under sub-section (1) shall be computed without giving effect to the provisions of the first and second provisos to section 48.”

Under sub-section (1), if this subsection ought to be applied, question arises as to “Whether the income from the head “Capital Gains” (condition (i)) is itself to be computed without considering proviso one and two (or) is to be applied only in respect of capital gains arising from long term capital asset (condition (ii))?”

Though one may tend to think that the said sub-section shall apply only in computing the LTCG on such specified assets, the position remains unclear on the face of the reading of this provision and therefore requires clarity. 

With the latest FAQ[8] released, the position of the CBDT is that the indexation under second provisio to section 48 shall not be available for computation of LTCG does not seem to clarify this position. In our view FAQ may not be conclusive about this position as the proposed law as it stands today does not expressly provide so.

3.2   Once LTCG on specified assets are computed as provided under 112A, there arises another interesting proposition as regards the taxability of LTCG up to Rs. 1,00,000. It is critical to understand how the term 'exceeding' in the context of this provision.

                The words used in section 112A sub-section (2) is as follows:

“(i) the amount of income-tax calculated on such long-term capital gains exceeding one lakh rupees at the rate of ten per cent.;”

 As the general perception in interpretation of this provision appears to be that Rs. 1,00,000 is to be understood as a standard deduction for application of tax rates. Alternatively, on plain reading it could also be understood that the rate of 10% would apply on any amount of LTCG exceeding Rs. 1,00,000. Though intent appears different, the ambiguity requires better clarity for applying this section to the true intent of the legislature. In our view it appears that the intention is to tax the entire amount of gains if such gains exceeds rupees one lakh.

Even under the FAQ[9] clarification, the aforesaid ambiguity is not addressed. It only seems to further suggest that entire gains shall be taxed if it exceeds one lakh rupees.

3.3     Sunset of section 10(38)

The benefit of section 10(38) shall continue in respect of shares sold on or before 31 March 2018. It is imperative to note that section 10(38) was amended by the Finance Act, 2017, to provide a narrower scope of exemption by restricting the benefit to equity shares which have been acquired on or after 01 October 2004 and which has suffered STT. Simply appears section 112A is also provided in a similar fashion.

In case the specified asset is purchased on or after 01 October 2004 and sold before 31 March 2018 shall still enjoy exemption[10] under section 10(38). Following situations are worth understanding post 2017 amendment to section 10(38):

The insertion of proviso to the effect of section 10(38), for denial of exemption is prospective from 01 April, 2018. Therefore, causing no tax liability on account of the section 112A proposed if sale of equity shares are before 31 March, 2018.

4              What happens if there are losses?

4.1    Now, having thought of certain issues in section 112A, it is also imperative to understand the situation[11] of losses on transfer/ sale of specified asset. In this context, the interplay between section 48 and 112A as regards the computation of capital gains shall be interesting. Consider the following situations[12]: