'Foreign Portfolio Investors Bear the Brunt of Taxation Flip-Flops'

A senior official at the finance ministry remarked a day after the budget that the most complex part of the Finance Bill proposals are contained in Part I of the first Schedule. Hidden in that part was application of additional slabs of surcharge, subjecting foreign portfolio investors (FPIs ) structured as Association of Persons (AOP), besides individual taxpayers, to higher rate of effective tax.

Progressive taxation is often used to mitigate societal ills associated with income inequality. The fact that firms and companies were spared shows that businesses were consciously left out and by that logic, its application to FPIs is an unintended consequence. The government's reluctance to clarify has merely raised anxiety levels.

FPIs have borne the brunt of India's taxation flip-flops. The 2018 budget proposal to levy long-term capital gains (LTCG) tax came at a time of slowing growth. With over $430 billion invested in India, FPIs have been growing steadily. FY18 attracted $18 billion after negative net investments in the previous two years. FPIs have generally been inspired with bold decisions on the economic front. This coupled with announcements in the past 18 months to allow FPIs to invest up to 25% in category III alternative investment funds , real estate investment trusts (REITs) and infrastructure investment trusts (InvITs), all three categories structured as AOP, kept up the pace of FPI investments.

Imagine an investor's anxiety on LTCG tax levy of 14.25%, which was exempt until 2018 and now a tax arbitrage of 5% (on short-term gains) between an FPI structured as a trust and corporate, and that too retrospectively from 1 April 2019?

Options for FPIs to rework their structure is impractical and unwieldy. Firstly, FPIs as a class of investors represent pension funds, investment trusts, hedge funds, asset management companies, university endowments, charitable trusts, sovereign funds, etc., by virtue of the Securities and Exchange Board of India regulations. Secondly, from a business structure standpoint, large investment groups who have dedicated funds are invariably structured as trusts in the US, companies in Luxembourg and partnerships in other jurisdictions.

Besides, regulations in multiple jurisdictions such as the US and the UK consider such portfolio investors as corporations irrespective of their legal form. To apply differential rate of taxation for same class of taxpayers, based on their legal status, sounds irrational, besides discriminatory and against the grain of economic theory.

Budget proposals to enhance the statutory limit of FPI investments up to FDI sectoral norms and permitting FPIs to subscribe to debt instruments of REITs and InvITs are well intended. FPIs shall however weigh such proposals with caution keeping in mind predictability of the tax regime. Even the Laffer Curve economic theory, which is suggestive of incremental increase in tax rates beyond a certain point proving counterproductive to raising tax revenue should compel India to relook at the recent budget proposals.

The article was first published in Mint on July 17. Views expressed are personal.

Living With Income-Tax: Going Back to the Era of High Tax Rates

This article has been co-authored by Priya Narayanan (Director, Deloitte Haskins & Sells)

Way back in 2004, a committee headed by Mr. Vijay Kelkar[1] made a few recommendations on the tax structure and functioning in India.  One interesting recommendation was that of making companies conduit so as to integrate corporate tax and personal tax. In other words, irrespective of which form of enterprise an entrepreneur choses to operate in, the net tax impact on his income should be the same. Today, if Mr. Shah chooses to run a business as a proprietorship over Mr. Singh choosing to run it as a partnership over Mr. Swamy choosing a corporate form, the tax rates should not vary.

One of the important recommendations of the Committee was to exempt long term capital gains tax payable on transfer of listed securities. By exempting capital gains tax on listed securities, the idea was to improve foreign investment into India. Following this recommendation, in the Finance Act (No. 2) 2004, an exemption was granted to long term capital gains arising from the sale of listed securities. This exemption benefitted both residents and non-residents.

Come 2018, the exemption is withdrawn and transfer of listed securities attracts capital gains tax albeit grandfathering of certain transactions. Let us now study the tax rates applicable to various transactions executed by listed companies i.e. prior to the Budget 2019 proposals:

Additionally, in case of a dividend, a recipient who earns more than INR 10,00,000 of dividend in a year is subject to tax at the rate of 10% (effective tax rate could approximately be 11.5%).  Tax credits for capital gains are normally available under tax treaty if the taxpayer is liable to tax in the country of residence.

And here comes, Budget 2019!

The taxman sees an arbitrage in buyback shares over distributing dividends. Interestingly, this amendment is housed under the section “Strengthening Anti-Abuse Measures”. Just a thought to ponder over, once we have a master anti-abuse provision (General Anti-Avoidance Rules) to tackle potential abuse to tax provisions, why do we need to strengthen every provision individually. If this logic is extended, we can continue making amendments to every provision of the Act to add volumes and pages and make the law more complex!

What is the change?

The proposal made in Budget 2019 is that if a company's stock is listed on the exchange and it proposes a buyback of shares, then from 5 July 2019, such buyback will be subject to additional income-tax at the rate of 20%.

The Companies Act 2013 permits buy back of securities proportionately from existing holders, from the open market or by purchase of securities issued to employees under stock option schemes.

The levy of tax is on the company declaring the dividend and not on the shareholder. In the case of a non-resident, this tax does not yield a tax credit under most scenarios. With respect to residents, this will be a final tax paid on the income.

Buyback tax was introduced to prevent the unlisted companies repatriate to intermediary holding companies by overcoming dividend distribution tax. Is this relevant for listed companies?

As per the provisions of Section 115QA of the Act, buy back tax is computed on the excess of consideration paid by the company over the 'amount which was received by the company for issue of shares'.  The question is over here is what constitutes amount received by the company. The 'amount received by the company' is further clarified under Rule 40BB which prescribes various modes of computation based on the manner by which shares were issued:

Rule 40BB contains a residuary clause wherein the face value of shares is deemed to be the amount received by the company for issue of shares in case the mode of issue does not fall under any of the other specific categories prescribed therein. While the Finance Bill 2019 proposed an amendment to Section 115QA to include listed securities, there is no commensurate amendment under Rule 40BB to compute 'amount received by the Company on issue of shares' in a scenario where the shareholder has bought shares from the secondary market.

Given the ambiguity here, recourse may be taken to the residuary clause deeming face value to be the cost price. Another similar issue could be where the bonus shares have been further sub-divided. The applicability of a deemed face value needs clarity.

Dividends are taxed on gross basis. However, shareholders continue to derive market value from the shares. However, a buyback includes repatriation of market value as well as premium. It may be unfair to conclude buyback tax has been introduced for companies as a measure of anti-abuse.

Many of these issue apply even in cases where a company whose shares are not listed intends to do a buyback. The company executing the buyback will also have difficulty in substantiating a step up in cost if there is one that the shareholder would like to take a position on.

This amendment along with the requirement to have 35% public float in listed entities could definitely impact the promoter stake in companies.

Ways to mop up tax collection:

If the interest of the Government is to mop up tax collections in the economy, then definitely increasing tax rates is not the only measure. Drawing cue from the Committee report in 2004, keeping a tax system simple and with a rate of tax that centres around positive behavior of citizens will definitely help in improving collections. In order to tackle tax evasion and incremental rate is going to do no good. Rather, evaluating steps to increase the income base will help. Similarly, if 'Make in India' has to be successful and driven to achieve progress, then the tax regime should support growth and not be a stymie.

[1] Report of the Task Force on Implementation of the Fiscal Responsibility and Budget Management Act, 2003

Budget 2019 - Impact on Start-ups

This Article has been co-authored by Krishnan T A (Director) and Riddhesh Shah (Associate).

Background

India has the third largest start-up ecosystem in world ahead of countries like UK, Germany and Israel[1]. The government, with a view to keep the entrepreneurial spirit high in the country and foster innovation, has come up with series of schemes for start-ups such as Start-up India, Stand-up India, Venture Capital Assistance Scheme and many more.

Among the key growth drivers for start-ups in India, 'Cost of doing business' is one of them[2]. A question arises here is whether enough has been done to keep the tax cost under control for start-ups and whether the much-debated issue of Angel Tax on start-ups is resolved.

Angel tax is tax on amount the Company receives towards issue of shares over and above the Fair value of shares as determined by the valuer.

Investors in Start-up entities very often infuse capital at significant premium on account of the growth potential that they foresee in the idea.

However, in recent times, the Income Tax Department started issuing demand notices seeking to levy an Angel tax to Start-ups that have raised capital in the past at significant premium. This created an atmosphere of uncertainty and confusion among the start-ups as this may not be of any help in fulfilling the government's intention to catalyse start-up culture and build a strong and inclusive ecosystem for innovation.

In response to the representations made by the fraternity, the government took series of steps to put to rest the issue of Angel tax whereby certain Start-ups fulfilling certain criteria were exempt from the ambit of section 56(2)(viib).

Angel Tax exemption was provided to Start-ups who fulfilled the following conditions cumulatively:

However, the job was not fully done yet. After coming into power with a thumping majority a lot was expected from the Modi 2.0 government by sections of society including the start-up community. The demand was to completely abolish the Angel Tax and to rationalize the provisions related to carry forward of losses for start-ups (Section 79 of the IT Act) which were partially addressed in the Budget.

Measures proposed by Budget 2019:

The start-up community had some key takeaways from the Budget. “Forget about Angel tax and focus on business” were the words of the CBDT chief following the budget day. The following are the measures proposed by the Finance Bill, 2019 for Start-ups:

How does it Impact?

Among the aforesaid measures, the first and the second pertaining to relaxation in levy of Angel tax and providing relief with respect to ongoing assessment were eye catcher and cherished by the start-up community. However, it is pertinent to note that this found mention only in the Budget speech, no amendments have been made neither new provisions have been introduced in the IT Act to put the same in effect. One hopes that the government comes of with the necessary notification to give effect to the stated intent in the Budget at the earliest.

While the Venture Capital Funds (sub-category of Cat I AIF) registered with SEBI were already exempt from the rigors of Angel tax, the domestic investors such as Private Equity funds (typically registered as Cat II AIFs with SEBI) which are lately investing growth capital in Indian start-ups were not provided immunity. By including Category II AIFs in the exception, the capital raised from such domestic Private Equity Funds shall also be immune from Angel tax.

The DPIIT in its notification issued on February 2019 had exempted eligible start-up fulfilling certain condition from section 56(2)(viib) of the IT Act. Among other conditions the paid-up share capital and share premium of the start-up should not exceed INR 25 Crs. In computing the said limit the funds raised from inter alia VCF shall not be considered since the same are exempt from section 56(2)(viib). Now since even Category II AIF are exempt, a suitable amendment to the said notification is needed. However, it did not find place in the Budget Speech.

It is not uncommon in the Start-up ecosystem that the founders or the promoters and even the investors exit the Company at attractive valuation, staying on board for a shorter span of time. Further, in case of start-ups raising of capital may lead to huge dilution of stake. There is constant change in shareholding pattern of a start-up and in certain cases, even more than half of the ownership may change. Thus, the amendment proposed by the Finance Bill to Section 79 is certainly welcome from the erstwhile position it would provide relief only to select cases fulfilling the conditions.

With regard to the eligibility for carry forward and set off of losses, the period is still restricted to 8 years like for all companies. Considering the innate business model that involves significant cash burn and huge initial investment, Start-ups may take a while before they start making profits and may not be able to utilize the losses as they might have lapsed.

Further, in order to be an eligible start-up, the turnover of an entity shall not exceed INR 100 Crores. This considerably limits the coverage and excludes the start-ups operating at higher level. Thereby limiting the benefit provided from Angel Tax and under section 79 of the IT Act.

As far as amendment to section 54GB is concerned, the same should assist in tax efficient fund raising avenues but the extent of impact it would have in promoting start-ups remains to be seen.

This being said, the question arises is whether the required steps have been taken towards the ultimate goal of promoting start-up or there still remains unfinished agenda.

The Unfinished Agenda……

Though various steps have been taken towards addressing the issues pertaining to Start Up's, there are still some indicative issues that still need to be addressed:

1. Firstly, the scope of the eligible start-up may be enlarged to bring within its ambit even the large start-ups as the fund raising is at significantly higher level as compared to small start-ups.

2. In case of Section 79, the proposed amendment has been made effective from 1st April, 2020 however the same may be considered to be made effective from 1st April, 2018 (when the section was amended to specifically introduce provisions for Start-ups), so that the companies whose shareholding changed in the interim period are also covered within the ambit.

3. The Budget speech only mentions special steps for ongoing assessment which does not include the cases where the order has already been passed and the matter is pending before appellate authorities. Any immunity for such cases shall be a welcome move.

4. It remains to be seen whether there shall be substantial increase in the compliance or providing excess information with regard to exemption form Angel tax as stated by the Finance Minister.

One hopes that the government continues its proactive approach to resolve the impending issues for Start-ups and creates an environment that fosters growth and entrepreneurship in the country.

[1] As per Nasscom - Zinnov Report

[2] survey report by Innoven Capital (survey of 140 founders)

A Peek into Proposals relating to TDS on Cash Withdrawals & 'Super-rich' Tax

After the resounding mandate in the recently concluded General Elections of the country, the Budget 2019-20 was presented by Mrs. Nirmala Sitharaman as Minister of Finance on 5th July 2019. The budget does neither contain any epoch-making bid nor any imaginative or innovative proposal. However, it holds a promise of making India a US $ 5 trillion economy in next few years through numerous proposals envisioned in the budget documents.

The present write-up deals with two proposals in the direct tax arena - the first being the proposal to introduce a TDS provision in the form of section 194N and the second being the proposal to tax the Super Rich by increasing the surcharge rates.

I. Referring to proposals of promoting digital payments, the Finance Minister has brought in a proposal in the Income-tax Act to levy TDS of 2% on cash withdrawal exceeding of Rs. 1 Crore from bank account in a year. This, as the Finance Minister states, is to discourage the practice of making business payments in cash. The proposal is sought to be implemented by way of introduction of section 194N in the Income Tax Act under the Chapter dealing with TDS provisions through Clause 46 of the Finance Bill.

Simply put, the new section provides that a banking company or a co-operative society engaged in carrying of the banking services or a post office shall deduct 2% as income tax from the aggregate of sum exceeding rupees one crore paid in cash during the previous year to any person from the account maintained by such person with either of them. The proviso to the section seeks to provide certain exceptions. Cash withdrawal upto rupees one crore shall not suffer TDS.

A cursorily reading of the proposed section throws up certain issues which need to be addressed.

1. The section refers to paying from an account. It does not refer to all accounts maintained by the person. This would imply that independent accounts, maintained by the same person, may be in the same branch, would lead to independent limits of Rs. 1 Crore per account.
2. The liability to deduct is on the banking company. This would mean that a single account operated from various branches shall always be treated as a single account and the limit of Rs. 1 Crore shall not be seen branch wise.
3. It shall be the responsibility of the bank to verify and confirm at the time of each withdrawal that the cumulated cash withdrawal do not exceed Rs.1 Crore. This appears to be uncalled for a burden on the banks in terms of TDS compliance.
4. The section refers to payment to any person. However, the person has been referred in the section as a “recipient” and the account from which the payment is made is also referred to as that of the “recipient”. Impliedly, payments made by bearer cheque would not be payment made to the account holder and may therefore still be out of the net of section 194N.
5. Clause 48 of the Finance Bill seeks to modify section 197 which provides for certificate for deduction at lower rate. Interestingly enough, section 194N has not been included therein. As such, there shall be no scope for lower deduction.
6. Specific industries/sectors having to deal with large volumes of cash will have to await the Central Government's Notification in the Official Gazette as provided in clause (v) of the proviso to the section 194N.
7. It should be noted that the Finance Minister introduced the concept of TDS on cash withdrawal by reasoning out that this is a proposal to discourage the practice of making business payments in cash. However, the section does not provide for withdrawal for business payments as separate from withdrawal for other payments.
8. It should also be noted that the Income Tax Act already has section 40A(3) to discourage making of business payments in cash. It may be noted that the provisions of section 40A(3) seek to disallow the claim of expenditure in the computation of business income where the payment is made, inter-alia, in cash. It is also interesting to note that section 40A(3) has a long history having been introduced for the first time in 1969.
9. The Budget speech refers to a bank account. However, the section refers to account with banks, specified co-operative societies and post office.
10. Curiously enough, provisions of section 206AA dealing with requirement to furnish PAN and a higher rate of 20% TDS in case of non-compliance remains a possibility under the proposed 194N, though it may appear academic.
11. Further, a corresponding amendment in section 204 providing the meaning of “person responsible for paying” seem to have been overlooked in the direct tax proposals.
12. Lastly, it appears that the placement of this provision in the Chapter relating to TDS is incorrect and lead to absurd results as for example in the case of application of section 198 which provides that tax deducted is income received.

The amendment by way of section 194N is to take effect from 1st September 2019. It is hoped that the Finance Minister shall take due note of the issues raised herein before the provisions of section 194N get to be implemented.

II. Thanking the tax payers for playing a major role in nation building, the Finance Minister has proposed the enhancement of surcharge on Individuals with a laudable thought that those in highest income brackets need to contribute more to the Nation's development. As such, as a revenue mobilization measure, it is proposed that surcharge is being increased to 25% and 37% respectively for incomes from Rs. 2 Crore to Rs. 5 Crore and incomes beyond Rs. 5 Crore from the existing surcharge of 15%.

This shall mean an effective increase of tax payable by 3% and 7% respectively for the income brackets referred to above.

The questions that this proposal raises are perplexing -

1. On one hand is reduction in corporate tax rate to 25% for companies with turnover upto Rs. 400 Crores as opposed to the current limit of Rs. 250 Crores, while on the other, we are seeing increase in the effective tax rate for individuals. If revenue mobilization was a concern, there need not have been a continuation of phased reduction of rates of corporate tax.
2. The Finance Minister, in the Budget speech, referred to enhancement of surcharge on Individuals. However, the fine print covers, inter alia, HUF, AOP and BOI. This has already caused a reactive selling in stock market from foreign funds/ FII's.
3. Talk of reintroduction of estate duty in the form of an inheritance tax was also doing rounds before the presentation of the Budget. Are we seeing the increase in surcharge as a substitute? May be yes, as inadequate revenue and higher administration costs may have worked against a new levy. In fact, wealth tax was abolished on these very counts.
4. Reduction in tax rates were earlier provided as rationale for better tax compliance and wider coverage of tax payers. If that is true, which it is, the proposed increase may have a counter effect triggering tax evasion in one form or the other.
5. A look at the numbers for A.Y 2017-18 culled out from the Indian Tax Returns Statistical data reveals that 85,541 returns of the total 4,98,68,380 returns reflected payment of Rs. 4,62,533 Crores, being 65% of the total tax payable of Rs.7,17,688 crores. According to the data, 85541 returns of all tax payers put together were having tax payable exceeding Rs.50 lacs. Therefore, it clearly appears that the present increase would impact a few thousand tax payers which is an insignificant part of the population of this country. It appears that the responsibility to contribute more to the Nation's development has been thrust on this number who may look to migrating their incomes to other attractive tax jurisdictions or to arranging their affairs such that incomes flowing to them are in some way not exposed to such tax.
6. In any case, meeting the fiscal deficit goals through revenue mobilization by way of increasing taxation on super rich appears to be an unworthy proposition.

Finance Bill, 2019 - Impact on FPIs & AIFs

This article has been co-authored by Prakhar Dua (Member, International Tax Advisory & Litigation, Nishith Desai Associates)

Introduction

Budget 2019 has brought an upheaval in a large part of the funds industry in India. The Finance Minister in her speech indicated that to “enhance surcharge on individuals having taxable income from ` 2 crore to ` 5 crore and ` 5 crore and above so that effective tax rates for these two categories will increase by around 3 % and 7 % respectively”. This has resulted in increase in effective tax rates to 39% for income earners earning more than INR 2 crores but less than INR 5 crores and 42.7% for income earners earning more than INR 5 crores.

While from the Finance Minister's speech, the intent seemed to be providing a higher tax rate to individuals only, the Finance Bill, 2019 (“Finance Bill”) seems to have a complete different story to tell. The increase in surcharge has increased the effective rates for the Foreign Portfolio Investors (“FPI”) set up as trusts  and the Category III  Alternate Investment Funds (“AIF”) to as high as 42.7%. This has come as a shock to the funds industry and has led to being one of the major factors behind  investors losing more than INR 5 lakh crores in market wealth recently[1].

While currently, a differential surcharge is applicable to FPIs set up  as corporate vehicles vis-a-vis others, considering that the difference in the rates had not been high, the effective tax rate did not cause too much of a concern. However, with the new proposal, the impact on the effective tax rates for FPIs set up as corporates vis-à-vis trusts is highly significant. For instance, the effective peak tax rate on short term capital gains tax on sale of equity shares by  an FPI established  as a company will be 16.38%, whereas the corresponding rate for an FPI organized as a trust will be 21.37%. Similarly, the proposed increase in surcharge directly affects Category III AIFs, since they do not have a statutorily encoded tax pass through status akin to  Category I and II AIFs.

In light of the above, several representations by stakeholders have been made to the relevant authorities in order to resolve this issue, however  the results have not been fruitful. While there have been comments from the Chairman of the Central Board of Direct Taxes (“CBDT”) suggesting that FPIs and AIFs could opt to get themselves structured as a corporate if they want to avoid paying the additional surcharge proposed under the Budget, no concrete solution t has been provided in this regard which has led to further dampening of investor sentiment. It should be noted that conversion of FPIs and AIFs into corporate entities is not as simple and straight forward as it sounds. This is on account of the fact that (i) most of the funds set up outside India and registered as FPIs with SEBI  make global allocations and are not merely India focused, and hence expecting a change in the corporate structure for one amongst many investment jurisdictions is unrealistic and not well thought through; (ii) various FPIs such as foreign pension funds may be statutorily or regulatorily required to be set up in a non-corporate format, mostly as trusts; (iii) FPIs which are set up under statutes of parliament do not have flexibility to change their legal forms; and (iv) akin to mutual funds which are established in the form of a trust with the possibility of having many different schemes running under an umbrella trust, most of the Category III AIFs have been set up as trusts as well for commercial feasibility and flexibility.. Further, it would be counter-intuitive, if the conversion is ultimately going to be attacked by the tax officer under the General Anti-Avoidance Rules (“GAAR”) to disregard such conversion.

However, on the positive front, the Budget has brought about a number of changes for FPIs and AIFs which may prove to be beneficial from them, which can be summarized below:

Exemption from Angel Tax for Category-II AIFs under Section 56 of Income Tax Act, 1961

Section 56(2)(viib) of the Income Tax Act,1961 ('ITA') is an anti-avoidance provision taxing the company issuing shares at a premium to resident investors on the difference between the consideration so received and the fair market value (“FMV”) of the shares. The provision provides an exemption in case consideration being received from a venture capital company or a venture capital fund. Venture capital funds only include Category I AIF. The Finance Bill, however, proposes to extend this exemption to Category II AIFs as well. This is a welcome move by the Government as it is likely to boost investments by Cat II AIFs in venture capital undertakings and will benefit a considerable number of AIFs as they are mostly set up as Category II AIFs.

Exemption from Tax on Capital Gains

Currently, non-residents are exempt from capital gains tax on transfer of GDRs, rupee denominated bonds (“RDBs”) and derivatives on a stock exchange in an International Financial Services Centres ('IFSC'). The Finance Bill proposes to extend this benefit to Category III AIFs located in an IFSC, subject to fulfilling the following conditions, i) derives income solely in convertible foreign exchange and ii) have only non-resident unit holders.

Extension of Pass Through Treatment to Losses of Category I & II AIFs

Under the current provisions, any income, barring business income, earned by Category I & II AIFs is exempt in the hands of such AIFs, and taxable directly in the hands of its investor(s) in the same manner and proportion as it would have been, had such investor received such income directly and not through such AIFs. However, losses suffered by AIFs (not being in the nature of business losses) could not be passed through to its investors for them to claim set-off of such losses against income earned by them.

As a welcome move, the Finance Bill proposes to allow losses incurred by such AIFs (not being in the nature of business losses) to be passed through to its investors. However, such loss pass-through can be availed only if the holding period of the units in the AIF by the investor is for more than 12 months.

Further, it has also been proposed in the Finance Bill to insert a new sub-section under Section 115UB of the ITA whereby, accumulated or unabsorbed losses (not in the nature of business losses) of such AIFs as on March 31, 2019 would be passed through to its investors to be carried forward / set-off against their income, provided that the investor was a holder of units of the AIF as on March 31, 2019. Such losses could be carried forward and accordingly set-off by investors from the year in which the loss first occurred subject to the period of limitation provided under the Chapter VI[2] of the ITA.

Lifting of the Statutory Cap for FPIs

The Budget proposes that FPIs will be permitted to invest up to the relevant sectoral cap, provided that the investee company will have the choice to limit this investment to a lower threshold. Presently, as per law, FPIs aggregate holding in a particular company is limited at 24% of paid-up equity value of the company on a fully diluted basis (unless increased to the relevant sectoral cap by the company). The said change will encourage capital market participation by FPIs and will also allow for increase in the India allocation for foreign ETFs which track global indices.

Some other changes to the FPI regime

The Budget has also proposed to (i) relax Know Your Customer (“KYC”) norms applicable to FPIs making them rationalized and streamlined, which ultimately makes them investor friendly and (ii) permit FPIs to subscribe to listed debt securities issued by REITs and InvITs thereby expanding investment options for FPIs.

Further, with a view to increase NRI's access to Indian equity market, the Budget proposes the merger of NRI Portfolio Investment Scheme (“PIS”) Route with FPI Route. It has also been proposed to permit FPIs to sell / transfer their investment in debt securities of Infrastructure Debt Fund - Non-Bank Finance Companies (“IDF-NBFCs”) to any domestic investor within the applicable lock-in period. The said move should enhance the sources of capital for infrastructure financing.

Conclusion

While the Government appears to have recognized and addressed some of the issues pertaining to AIFs / FPIs in India, the increase in surcharge has resulted in investors losing trust in the Indian market and may result in being the biggest dampener to the government's objective of attracting maximum foreign investment into India. The Indian economy has been sluggish in the past couple of years and with a radical move such as this, there arises a question as to whether India would actually be able to reach the USD 5 trillion economy in the next few years as is the vision of the current government. A tax system which is based on certainty and reliability still remains the need of the hour. Please note that, even after representations in this regard have been made, there have been no changes to the rates even in the amendment to Finance Bill which was introduced in Parliament yesterday.

[1]https://www.businesstoday.in/markets/stocks/sensex-nifty-investor-lose-market-wealth-post-union-budget/story/362630.html

[2] Aggregation of Income And Set Off Or Carry Forward Of Loss.

Bridling Charitable Trusts and Institutions - Amendment to Sec. 12AA

The article has been co-authored by Vignesh Krishnaswamy (Chartered Accountant).

A Prelude

This budget has been the most anticipated one of the new Government, since it is expected to give a direction for the growth of this country, which is now clearly an “Aspirational India”. The newly elected Government and the new incumbent Finance Minister, Smt. Nirmala Sitharaman, has set the ball rolling for this new Government with the new set of fiscal and economic policies.

In our article, we have endeavoured to highlight the impact of the amendment to Section 12AA and the challenges that the amendment may pose to the already existing controversies pending before various judicial forums, with reference to charitable organisations under the Income tax Act, 1961 ('the Act').

B  Amendment to Provision of Law

Section 12AA.

(1) The Principal Commissioner or Commissioner, on receipt of an application for registration of a trust or institution made under clause (a) or clause (aa) [or clause (ab)] of sub-section (1) of section 12A, shall—

(a)  call for such documents or information from the trust or institution as he thinks necessary in order to satisfy himself about the genuineness of activities of the trust or institution and may also make such inquiries as he may deem necessary in this behalf; and [Proposed deletion by Finance (No.2) Bill, 2019]

“(a) call for such documents or information from the trust or institution as he thinks necessary in order to satisfy himself about,--

(i) the genuineness of activities of the trust or institution; and

(ii) the compliance of such requirements of any other law for the time being in force by the trust or institution as are material for the purpose of achieving its objects,

and may also make such inquiries as he may deem necessary in this behalf; and”;

[proposed insertion by Finance (No.2) Bill, 2019]

(b)  after satisfying himself about the objects of the trust or institution and the genuineness of its activities as required under sub-clause (i) of clause (a) and compliance of the requirements under sub-clause (ii) of the said clause, he— [proposed insertion by Finance (No.2) Bill, 2019]

1. shall pass an order in writing registering the trust or institution;
2. shall, if he is not so satisfied, pass an order in writing refusing to register the trust or institution, and a copy of such order shall be sent to the applicant:

Provided that no order under sub-clause (ii) shall be passed unless the applicant has been given a reasonable opportunity of being heard.

(4) Without prejudice to the provisions of sub-section (3), where a trust or an institution has been granted registration under clause (b) of sub-section (1) or has obtained registration at any time undersection 12A [as it stood before its amendment by the Finance (No. 2) Act, 1996 (33 of 1996)] and subsequently it is noticed that:

the activities of the trust or the institution are being carried out in a manner that the provisions of sections 11 and 12 do not apply to exclude either whole or any part of the income of such trust or institution due to operation of sub-section (1) of section 13, then, the Principal Commissioner or the Commissioner may by an order in writing cancel the registration of such trust or institution: [proposed deletion by Finance (No.2) Bill, 2019]

“(a) the activities of the trust or the institution are being carried out in a manner that the provisions of sections 11 and 12 do not apply to exclude either whole or any part of the income of such trust or institution due to operation of sub-section (1) of section 13; (or)

(b) the trust or institution has not complied with the requirement of any other law, as referred to in sub-clause (ii) of clause (a) of sub-section (1), and the order, direction or decree, by whatever name called, holding that such non-compliance has occurred, has either not been disputed or has attained finality,

[Proposed insertion by Finance (No.2) Bill, 2019]

Provided that the registration shall not be cancelled under this sub-section, if the trust or institution proves that there was a reasonable cause for the activities to be carried out in the said manner.

C  Analysis

The proposed amendment to the provisions of section 12AA appears to have been enacted with an object to weed-out the non-compliant Charitable Trusts which violate the Indian laws, though they may be compliant with the provisions of the Income tax Act, 1961. Although the intent of the government and the rationale behind the amendment is to bring about discipline and make Charitable trusts compliant under the Indian Regulations, the amendment may lead ramifications that may be far-reaching and possibly counter-productive.

When we analyse any new provision under the Act, it may only be appropriate to first understand the intent of the legislators through the Memorandum to the Finance Bill. The Memorandum to this Finance Bill explains the reasons for the amendment to section 12AA as follows:

“In order to ensure the trust or institution do not deviate from their objects, it is proposed to amend section 12AA…….”.

Given this background, we intend to analyse the proposed amendment. One may now want to connect the reasons stated in the Memorandum explaining the amendment, i.e., proposing to ensure that a trust or institution do not deviate from the object, and the amendment actually providing to disentitle a trust or institution with registration u/s. 12AA for reasons of non-compliance with any other law in India. On a careful reading of the memorandum explaining the amendment and the actual amendment proposal, there appears to an unbridged gap. The intent of regulating the charitable trust or institutions so that they, “do not deviate from their objects” and denying or cancellation on the basis of “compliance with the requirements of any other law” as a measure of tax law regulation appear to be contrasting and unsound. Even in case the activities of the trust are genuinely for charitable purposes, without deviating from the objects of the trust, and if there be any lapse on compliance requirement under any other law for the time being in force, disentitlement of registration by a sweeping and wide coverage of the provisions under section 12AA appears to be unfair and harsh.

C.1 Impact of amendment on Fresh Registrations - Section 12AA (1)

Firstly, let us take the case where fresh Registration under section 12AA, the provisions of sub-section (1) currently contemplates the satisfaction of the genuineness of the activities (based on the activities proposed to be carried on or activities which have already been carried out or both) by the Commissioner before grant of approval. It is interesting to note that the law does not contemplate whether the activities of which the Commissioner is to be satisfied is of that of the past activities (or) current activities (or) proposed activities, however the approval for registrations are being granted based on past or proposed activities as of now. The proposed amendment casts the duty on the authority to satisfy additional conditions as to the compliance with the regulations under any other laws for the time being in force in India.

The amendment to sub-section (1) of section 12AA in clause (a) and sub-clause (ii) shall now provide that, unless the Commissioner is satisfied about, “ the compliance of such requirements of any other law for the time being in force by the trust or institution as are material for the purpose of achieving its objects,”, he shall not grant registration for the trust or institution under section 12AA.

This shall imply, that for the purposes of initial grant of registration, what the Commissioner essentially needs to satisfy is that the Trust is compliant with laws that are material for the purpose of achieving its objects. Such a wide coverage of this provision (of being compliant with requirements of any other law) may pose the following challenges:

• In case a trust does not comply with the local laws of the municipality at the time of making an application under this section, however, regularises the same later and before the Commissioner could pass his order on the registration, can the Commissioner deny the registration under section 12AA to the trust on the basis of aforementioned non-compliance with municipal regulation? Here, the amendment does not contemplate an aspect of a subsequent correction/ regularization of such non-compliance prior to grant of such registration under section 12AA. Hence, the law leaves the authority with a wide discretion and uncertainty for the trusts and institutions.
• The terms “compliance of such requirements of any other law…….as are material for the purpose of achieving its objects”, may leave further room for more litigations on the grant of registration under section 12AA. This would mean that what would be a material compliance for one trust/ one set of objects, may not be material for another trust/ different set of objects. Hence this could leave room for wide range of disputes and differences. What could constitute a “material” compliance having regard to the object of a trust, shall itself be a question to debate.
• Another key aspect is that, whether the Commissioner would be equipped with all State and Union laws or be able to identify each of those compliances, that a trust may require to comply for the set of objects for which it is formed, is questionable. Say for instance the object of the trust is to promote education. Now, Trust A may have the object of promoting primary school education, Trust B, may have the object of promoting sports education, Trust C may have the objective to promote Arts and cultural education, in order to satisfy it would be extremely important for the Commissioner to identify, check and validate all such requirements under any other laws to be complied with. Further complexities arise when the activities are carried out across various states in India, involving various State Laws, Municipal Laws, Panchayat Regulations (if any), etc.
• Let's take another case where the trust carries on a business through an LLP where it is a Partner and derives income from such business. In a case where there is a non-compliance on the part of the LLP under the LLP Act, 2008, should this be a lapse that shall non-compliance as contemplated under the new sub-clause (ii) and consequently registration be denied?
• Next questions comes to, whether by the time all the above are satisfied, limitation period of 6 months would be sufficient for the Commissioner to grant approval. This proposed amendment may leave a mounting pressure of work on the Commissioners and deplete the quality of work and orders passed.
• One may even think whether the Act could even impose itself to the satisfaction or compliance with any other law for the time being in force would be appropriate within its scope. The object and scope of the Income tax Act, 1961 is, “To consolidate and amend the law relating to income tax and super-tax”. In such a case, 'Can a subjective condition, as aforementioned, with reference to other laws for the benefits to be granted under this Act be sustained?'. However, the other school of thought that may arise is that the provision only relates to grant of registration and regulating the benefit of exempting incomes derived by charitable trusts or institutions and hence may still be intact with a law.

Hence this proposed amendment does contemplate to tighten the noose and pave way for only genuine charitable trusts to carry on the charitable activities, however, the sweeping change such as this could have been implemented to reduce the income tax benefit with congruous measures by specific legislative enactment for regulating the Charitable Trusts.

Interesting to note that under sub-section (1) unlike sub-section (4) (discussed later), for grant of fresh registration, the law does not contemplate crystallization of non-compliance beyond doubt. What appears to have been envisaged under sub-section (1) is that the trust or institution making application for registration should be compliant with necessary aspects with reference to the objects/ activities, that it proposes to undertake at the time of application. That, however, is so widely provided that the tax authorities are bound to read it beyond the scope in the absence of more detailed explanation for proposing the need for such amendment.

C.2 Impact on cancellation of existing registration - Section 12AA (4)

With reference to the powers under sub-section (4), on the cancellation of existing registrations, the proposed amendment also seeks to ensure that the existing charitable trusts or institutions who have already obtained registrations have complied duly with the other laws. Failure to compliance with such other law shall imply that the Commissioner is given the power to cancel the registration issued under section 12AA.

The proposed amendment seeks to insert the following clause (b) to sub-section (4) of section 12AA and the extract is provided below:

(b) the trust or institution has not complied with the requirement of any other law, as referred to in sub-clause (ii) of clause (a) of sub-section (1), and the order, direction or decree, by whatever name called, holding that such non-compliance has occurred, has either not been disputed or has attained finality,

In bringing out the above amendment, the law appears to provide for cumulative satisfaction of two conditions:

1. that the trust or institution has not complied with the requirement of any other law; AND
2. the order, direction or decree, by whatever name called affirming the non-compliance, which order has either attained finality or such order, direction or decree is not disputed by the trust or institution

Therefore, unless both the conditions are satisfied, the cancellation of section 12AA registration on account of non-compliance cannot be sustained.

This would mean that the Commissioner, even on identification of a non-compliance with any other law by him and such non-compliance is not witnessed by the concerned authority, cannot initiate cancellation of registration or issue show cause for cancellation in the absence of such affirmed non-compliance.

C.3 The term “requirement of any other law”

Both in the context of sub-section (1) & (4), it may be interesting to note the meaning that could be assigned to the terms “requirement of any other law”. Advanced Law Lexicon[1] defines the term “Requirement of law” from which the meaning for the aforementioned term could be inferred and defines as:

 “The term “requirements of law in the Registration Act cannot be restricted to any particular statute i.e., the law of registration. It must mean the whole body of law. Any other law for the time being in force is also included in the term.”

Hence the coverage of the term “requirement”, in this context, shall not be merely restricted to registration requirements but also any other aspect of compliance, however small or big the requirement may be with reference to the compliance of laws.

C.4 Effective date of amendment

The Finance (No.2) Bill, 2019 provides that the amendment shall be effective from 01 September 2019. This would mean that the amendment shall be prospective in nature and not retrospective.

Now, the question which one may think of is, 'whether the amendments can be applied for cancellation of registration with retrospective effect?' for a non-compliance which had arisen after the grant of registration. In this context, Courts have held that the registrations cannot be cancelled retrospectively and hence in this context the cancellation cannot be made from a retrospective date based on this amendment coming into effect.

D  Concluding remarks

In the recent times, the Government has been making some sweeping amendments to curb harmful practises and as a measure to protect the tax base. In our view, the following aspects remains a grey area and the arbitrariness in the law, as how it now appears in the proposed amendment, may require legislative clarification:

1. The law does not specify, if once the registration is cancelled on account of non-compliance with any law, can the trust or institution re-apply for registration later on rectification of such non-compliance, remains unanswered.
2. In case on non-compliance, should the event of non-compliance matter or the date of effective crystallization in the respective cases of fresh registration or cancellation of existing registration be regarded as non-compliance on the part of the trust or the institution.
3. Where, in case an institution or trust enters into a contractual obligation with a third party and in such a situation on some account the trust or institution fails to honour the contract. Can it also be treated as a non-compliance under the Contract Law and stretch the parameters much beyond the intended scope?
4. If a non-compliance is rectifiable under the relevant law, can the Income tax Act authorise the authority to cancel the registration, without having regard to the remedy or recourse available under the relevant law. 
5. In both sub-section (1) and (4), the cancellation based on non-compliance with any other law shall only be with reference to the activities of the trust or institution. Any non-compliance on the part of the office holders on any other aspect, cannot be held as a ground for non-compliance on the part of the trust or institution.

From the above few illustrative situations which we could envision, what appears to have been visualised to target non-compliances under the Economic and Revenue Laws (such as the Foreign Contribution (Regulation) Act, 2010, Prevention of Money Laundering Act, 2002, etc.,) could now be made too elastic and be stretched beyond boundaries.

One could ponder in the context of the above, whether “non-compliance with requirements of any other law” would include or be one and the same as “infraction of any other law”, and this could be a subject for another day. It may be important, therefore, that laws of the country are integrated with the object that it desires to achieve and making it less arbitrary. For growth and streamlining existing laws to put the country into a new path it requires changes, and as professionals in these changing times one can expect interesting times ahead of us with more issues and fresh round of litigations.

[1] By Ramanathan Aiyar - 3rd Edition Reprint pg. 4084

NBFCs ! Beware of INTERESTing Dilemma

Now that the changes in the finance bill are final, no more 'budget expectations”. Its time to face it and prepare for the change and act on them.

As it is often said the devil lies in the detail. This applies to changes relating to NBFC sectors as well. While regulatory arbitrage between banks and NBFCs have reduced over the years and tax treatment under indirect taxes for banks and NBFC is quite similar, disparity or discrimination under income tax laws as well as complications continue in certain areas.

As major lender to certain segments of the society, one such area is obviously taxation of interest income. Bank pay tax on interest on NPAs only when actually received or collected unless accounted for in books. However, this section does not cover NBFCs.  RBI require interest on NPAs to be recognised by NBFCs in the books of accounts on receipt basis and not on accrual basis. Income Computation and Disclosure Standard required interest to be computed on time basis. This had resulted in huge litigation that went right upto Supreme court. The Finance Bill, 2019 proposes to be amended to allow the flexibility of taxing interest on receipt basis to deposit taking NBFCs and systemically important NBFCs from current financial.

This proposed amendment was meant to make life easy for NBFCs but, surprisingly only deposit taking and systemically important NBFC are covered but others in particular non deposit taking NBFCs are been left out from the amendment. No rationale has been provided in the budget documents for this exclusion.

Even for the NBFCs meant to be covered by the relaxation, several fresh issues as discussed below will arise and need to be addressed by the industry.

1. What is considered to be an NPA (NPA recognition) - Income tax rules currently provide for categories of NPAs interest on which would be taxable on receipt basis. Till now these rules applied to banks and now specified categories of NBFCs will have to follow these rules. This would effectively mean following different norms for regulatory and tax purposes and accordingly maintaining records or databases and reconciliation in case of mismatch. 
2. Impact of accounting standards - All systemically important NBFCs have adopted Indian Accounting Standards (Ind AS) from Financial Year 2018-19. Under Ind AS, NBFCs are complying with Expected Credit Loss (ECL) model for recognising provisioning. NBFCs will have to recognise interest income on NPAs on net debt basis i.e., gross debts less provisioning done. Hence, out of total interest income (say INR 100) on NPAs, a part of interest income on NPAs is recognised on net debt in the year of NPA recognition and the balance is recognised at the time of actual receipt in the profit and loss account. Thus, under Ind AS, entire interest income on NPAs will some interest will have to accounted as income in the books of accounts initially and the balance later on actual receipt. Accordingly, after the proposed amendment does not help so far as interest income on NPAs that has to be credited in books of account.
3. First year of Ind AS adoption - Upon convergence to Ind AS, a company is required to reinstate its opening balance sheet as per Ind AS accounting principles. Upon such reinstatement, NBFCs will record some portion of interest income as part of opening balance sheet and such adjustment will form part of other equity/reserves in the balance sheet. Since, such interest income has not been credited to the profit and loss account of current year but has been recorded directly in the balance sheet as part of other equity, taxability of such interest income need to be analysed under the proposed amendment. Taxation of such interest either in the respective earlier years or in the current year or in the year of actual collection or realisation would be subject to multiple interpretations.
4. Credit for tax deducted by borrowers - Currently the law provides that credit of tax deducted at source by borrowers shall be available in the year in which income is offered to tax. Upon adaption of Ind AS, NBFCs shall be taxed in different yeas as discussed above though the borrower would deduct tax at the time of payment. NBFCs would be required to keep adequate records and reconciliation for identifying tax credit not claimed as regard income offered to tax in past years. This is likely to pose operational challenges. Had interest income earned by NBFCs been exempted from TDS on the lines of interest paid to banks, it would have provided a great relief to NBFCs from practical difficulties and maintaining TDS data for multiple years.
5. Non deposit taking NBFCs - Non deposit taking NBFCs will have to continue with their tax provisions adapted considering ICDS provisions and judicial precedents and will have to offer interest income on NPAs to tax accordingly.

Another area of ambiguity and hence likely litigation is interest paid on funds borrowed through perpetual debt instruments (PDIs) issued by NBFCs. A few years ago, RBI permitted such instruments to qualify as tier-1 capital base under the capital adequacy norms. Hence these PDIs are being increasingly used by NBFCs to augment capital and strengthen balance sheets. These PDIs offer a fixed rate of periodical interest but they do not have any fixed term or period of maturity or redemption and the subscribers do not have the right to enforce repayment of the principal. The borrowing NBFC has the call option, i.e. right to redeem PDIs from lenders after the expiry of a predefined time period (say 10/15 years).

There have been disputes on characterisation of interest payment as interest or dividend and hence its deductibility. Since PDIs do not provide the subscriber with any means to enforce repayment of the principal amount, it is akin to 'equity' and not 'borrowings' or 'debt'. However, practically subscribers get taxed on the income as interest hence it is not fair to deny deduction to the payer NBFC. In the absence of any guidelines on the circumstances in which such instruments would be treated as debt and interest would be deductible, NBFCs would have to adopt positions based on certain judicial precedents and draw support from international practices.

In certain other respects tax neutrality of mergers, percentage of tax deduction for NPAs, etc the industry will have to live with disparity as compared to banks.

Upsurge in Surcharge for Individuals to Impact the Corporates Heavily!!

This Article has been co-authored by Neeraj Shrama and Mital patel.

Background:

The Finance Minister, Nirmala Sitharaman, presented Union Budget 2019 on 5 July 2019. While individual taxpayers were eagerly expecting some relief in tax rates, no changes were proposed in the tax rates for individuals.  However, surprisingly, the rate of surcharge for the Individuals, Hindu Undivided Family (HUF), Association of Person (AOP), and Body of Individuals (BOI) is proposed to be increased significantly for the high-income earners.

Under the current provisions, a surcharge is levied at the rate of 10% and 15% respectively when the income exceeds INR 5 million and INR 10 million. It is now proposed to increase the surcharge at the rate of 25% if the income ranges from INR 20 million to INR 50 million and at the rate of 37% where the income exceeds INR 50 million. Accordingly, the effective tax rates for the individuals earning income above INR 20 million will be as under:

The above increase in surcharge causes quite a steep surge in the effective tax rates for the individuals[1] i.e., 8.69% and 19% respectively for the above two ranges of income.

It is quite interesting to note that the above increase in the rate of surcharge shall not only impact the individuals, but shall also have an indirect impact on the corporates as well.

How an increase in the rate of the surcharge shall impact corporates?

In India, generally, the tax liability is borne by the employers in the case of expatriate employees. This is specifically true for the Indian subsidiaries or Project/ Branch/ Liaison offices of Multinational Enterprises (MNE) where expats are deputed from the group/parent company. The basic objective behind bearing this liability is that the MNC groups do not want to put their employees to suffer more taxes than that they would have incurred in their home country. To compensate the employees for the excess tax, the MNC group bears the extra tax so that the employees net take home is not less than what they would have earned in their home country.

Under the Indian tax provisions, the tax liability of the employees borne by the company is considered as a tax perquisite and requires grossing-up for computing the tax liability of the employees. Additionally, the expats are subject to social security in India unless they are coming from the countries with which India has entered into a Social Security Agreement. The Social Security contributions of the employees borne by the employer are also liable to tax along with salary.

The increase in the rate of surcharge would exponentially increase the tax cost where the company is bearing the tax liabilities and/or social security contribution of the employees deputed to India. The same is explained through an example.

Assuming, Indian Company A has an expat whose salary income is INR 30 million and his taxes are borne by the Indian Company. The effective tax cost of the expat after an increase in the surcharge shall be as under:

(Amount in INR in Million)

The effective tax cost of the company for the expats shall increase nearly by 11.2%, although the increase in the effective tax rate for individuals is 8.9%. Further, in situations where Social Security cost is also borne by the employer, it would cost much higher due to the circular impact.

Given that the tax liability, in the case of expats, is generally borne by the Indian establishments of the MNEs, they would also get adversely impacted and will have to be mindful about the effective tax cost while paying salary net of taxes to the Expats deputed to India.  The impact could be much severe due to the effect of the multiple grossing up as the tax borne on the perquisite would also constitute perquisite. Currently, everybody is talking about the tax on HNI and subsequently tax on FPIs (as the increased surcharge is also applicable on AOP); however, it seems that people are caught unaware about the steep impact such increase in surcharge would have on the corporates, especially the MNC group.

[1] Difference in the effective tax rate over the existing tax rate

[2] Tax perquisite is considered as non-monetary perquisite based on judicial decisions and therefore considering exemption under Section 10(10CC) of the Income-tax Act, 1961 only single grossing up is done. Section 10(10CC) provides exemption from grossing up in case on non-monetary tax perquisite.

[3] Tax liability is computed considering the maximum marginal rate and ignoring the average slab rate.

Revival of Stressed Companies - Hits and Misses in the Finance Bill, 2019

This Article has been co-authored by Suraj Malik (Partner, BDO India LLP) and Anant Jain (Director, BDO India LLP)

The first woman full time female Finance Minister, Ms. Nirmala Sitharaman has presented her maiden budget. While the overall theme and vision of the comprehensive and inclusive budget was to boost the Indian GDP, lower the fiscal deficit, improve ease of doing business, ease of living and improving the life of farmers and women, the Finance Minister has also brought some cheers for the resolution of assets under insolvency process.

The announcement made by the Finance Minister in relation to tax relief demonstrate and support the commitment and willingness to implement the 'ease of doing business' and 'minimum government maximum governance'.

We had highlighted top three issues that should have been addressed to bring relief and facilitate resolution of stressed companies

The hits and misses in budget proposal are summarised below:

Hits:

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

These provisions in the Act were introduced as anti-abuse provisions to discourage the transactions entered into to avoid tax and as a curb to generate black money. In case of revival of stressed companies, generally the shares are transferred at lower price than the value determined as per prescribed rules.

Therefore, taking cognizance of genuine hardship for these cases, Budget 2019 has proposed to exclude certain transaction from the applicability of section 56(2)(x) and 50CA of IT Act. Though, the exact rules and conditions are yet to be prescribed, but as per memorandum to Finance Bill, the exemption for companies under IBC is likely.

2. Carry forward of losses of a stressed company, its 'subsidiary' and its 'subsidiary of subsidiary'

In October 2018, the Central Government has substituted the IL&FS's board by six new members, pursuant to an order of National Company Law Tribunal ('NCLT') u/s 241 of the Companies Act, 2013, due to lacking in corporate governance and failure to honour its debt obligation leading to its operations prejudicial to the interest of public.

Section 242 of the Companies Act, 2013 empowers NCLT to pass any order, as it thinks fit, which inter-alia includes the change in shareholding of the company. Such an order may trigger section 79 of IT Act resulting into lapse of losses.

Therefore, in order to protect the losses of such a company wherein the change in shareholding is not motivated to avail the benefit of tax losses, the Finance Minister has proposed to allow to carry forwarded of losses of such company, its subsidiary and its 'subsidiary of subsidiary' if the change in shareholding is pursuant to an order of NCLT u/s 242 of the Companies Act, 2013. Further, for the purpose of calculating book profit under MAT for such companies, the aggregate of book losses and book depreciation shall be allowed instead of lower of two as per current provisions.

Misses:

Key issues that remain to be addressed in the budget proposal are:

1. Impact of change in shareholding of subsidiary of stressed companies under IBC or revival of companies outside the IBC should also be outside the purview of Section 79. There will remain a lot of subjectivity involved in dealing with tax authorities to claim the tax losses of stressed companies.

2. Exclusion of write-back from book profits for MAT purposes pursuant to write back of loan (including interest) and other debt and claims.

Disclaimer: Views expressed are personal.

Budget Proposals on Startups

This article has been co-authored by Jagannathan M (Senior Manager).

The Modi Government, in its second innings, has set the tone in Union Budget 2019 to make India a $ 5 trillion economy by 2025. Its vision statement for the decade, among other things, envisages its priorities on building infrastructure, bolstering Digital India, improving water management, and places an emphasis on the growth of startups and the MSME sector under its flagship make in India programme.

This article focuses on various direct tax proposals made in Budget 2019 for startups.

Angel Tax issue

Section 56(2)(viib) of the Income-tax Act ('the Act') provides that where a closely held company receives, from a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be charged to tax.

The existing provision provide for exemption for consideration received by venture capital undertaking for issue of shares from a venture capital company or a venture capital fund. Currently, the exemption is available to Cat-I AIF. The budget has proposed to extend the exemption to Cat-II AIFs as well.

The proposed amendment is in line with Industry demand for extension of such exemption Cat-II AIF funds as well.

The Ministry of Commerce and Industry and the CBDT vide notification in February 2019 / March 2019 has exempted applicability of section 56(2)(viib) of the Act to eligible startups if certain conditions are satisfied and a declaration in this regard has been submitted with Department for promotion of Industry and Internal Trade (DPIIT). The said notification provides, inter-alia, the below conditions:

• Startup shall be eligible startup upto a period of 10 years
• Will continue to be a eligible startup if its turnover does not exceed Rs. 100 crores
• Aggregate paid up share capital and share premium does not exceed 25 crores post issue of shares
• Startup has not made investment in land and building (residential purpose), capital contribution to any other entity, shares and securities, motor vehicle, aircraft, yacht, etc.

With a view to ensure compliance to the conditions specified in the notification, the government has proposed to provide that in case of failure to comply with the conditions, the consideration received for issue of shares which exceeds the face value of such shares shall be deemed to be income of the company chargeable to income-tax for the previous year in which failure to comply with any of the said conditions has taken place.

The above amendment is intended to bring the scenarios under tax net where the conditions provided under the above notification are not met similar to section 47A.

However, it is pertinent to note that the amendment provides to tax the difference between the “consideration received” and “face value” of shares even though the main section provides for taxing the difference between “consideration received” and “fair market value” as per rules. In other words, the scope of proposed amendment is ultra vires to the main section itself. The above provision is explained by way of an Illustration below:

Currently, as per section 56(2)(viib), difference between fair market value (30) and issue price (50) i.e. Rs 20 would be taxable. However, as per the above amendment, if the eligible startup fails to comply with the above conditions then the difference between the face value (10) and issue price (50) i.e. Rs 40 would be taxable.

Typically, a startup in its budding stage requires large sum of capital for expansion and innovation, etc. Given the same, the finance bill has not provided any relief by increasing such capital threshold from its current level of Rs. 25 crores.

Section 56(2)(viib) was introduced as a measure to deter the generation and use of unaccounted money by infusing fund into a company for acquisition of shares at higher valuation and transferring such shares below cost. However, the tax authorities indulged into applying the said provisions for startups as well. Since an investor investing into a startup at its early stage has no intention of taking any tax advantage / to generate and use unaccounted money the section itself shall not be applicable. Given the same, appropriate exemption shall be provided in the Act for all the startups with bona fide business and investment from a legitimate source of funding.

Legacy angle tax issue

In addition, special administrative arrangements shall be made by Central Board of Direct Taxes (CBDT) for pending assessments of startups and redressal of their grievances. It will be ensured that no inquiry or verification in such cases can be carried out by the Assessing Officer without obtaining approval of his supervisory officer.

Expansion of provision relating to carry forward and set-off of losses

The existing provisions provide that, in case of eligible startups, losses can be carried forward and set off if “all the shareholders” who were shareholder in the year in which losses were incurred continue to be shareholders in the year of carry forward and set-off ('all the shareholders' condition).

Further such loss can be carried forward, if the startup has incurred such losses during the period of seven years beginning from the year of incorporation.

For other companies, losses can be carried forward and set-off if shareholders holding at least 51% shares were shareholders in the year in which losses were incurred, continue to be shareholders in the year of carry forward and set-off ('51% shareholders' condition).

To further facilitate ease of doing business for eligible start-ups, it is proposed to provide flexibility to startups to comply with either 'all the shareholders' condition or '51% shareholders' condition in order to carry forward and set-off of losses.

The above amendment is analyzed by way of an illustration as below:

Carry forward and set-off for year 3

As per the existing provisions, losses of previous year and current year of INR 350 crores shall allowed to be carried forward under section 79 since all the shareholders condition is met.

Carry forward and set-off for year 4

Existing Provisions

• Losses of year 1 to 3 of INR 350 crores shall lapse since all the shareholders do not continue to be shareholders in the year of carry forward and set-off.

Proposed amendment

• Losses of INR 200 crores of year 3 shall be allowed to be carry forward since 51% shareholders condition is met even though all the shareholders conditions is not met.
• However, losses of INR 150 crores of year 1 and 2 shall lapse since neither 51% ownership condition nor is all the shareholders conditions is met.

Further, as per the existing provisions, losses incurred by an eligible startup after 7 years from the year of incorporation were not allowed to be carried forward. Post the amendment, losses incurred after the 7 years from the date of incorporation shall now be eligible to be carried forward if the '51% shareholders' condition is met.

Extension of sunset clause for exemption of capital gains

The current provision u/s 54GB provides for exemption of capital gains arising on transfer of house property if the net consideration invested in eligible startups. The assessee is required to invest in more than 50% share capital or acquire similar voting rights. The section provides for restriction on transfer of assets by the company for five years from the date of acquisition.

To incentivize investment in eligible startups, it is proposed to extend the sunset date of investment from 31st March 2019 to 31st March 2020. In addition to the aforesaid measure, the condition of minimum shareholding or voting rights has been relaxed from 50% to 25%.

Conclusion

While the Budget has taken few steps in the right direction to promote startups, it has to be seen how the government is going to deal with the legacy litigation and with startups which are not covered under the February 2019 notification in spite of being valued appropriately and funded from a legitimate source or shareholders.

Yet Another Tax 'Amnesty' Scheme, But it's a WIN-WIN Situation!

The article has been co-authored by Mr. Joseph K. Antony, Senior Associate. The authors were assisted by Mr. Karan Dhanuka, Advocate. 

FM Nirmala Sitharaman's well-thought-out Budget 2019 presentation could turn out to be a boon for litigants facing challenges over pending legacy Service Tax and Excise Duty matters across all dispute fora. Taxpayers have been muddled with contentious and trivial excise and service tax issues involving time-consuming litigation, given the fact that Goods & Services Tax (GST) has subsumed most indirect tax laws from July 2017. Similarly, Revenue had been feeling the twinge with simultaneous administration of legacy issues coupled with an effective regulation of the newly born GST law. It was, thus, timely for the FM to announce the Sabka Vishwas (Legacy Dispute Resolution Scheme), 2019 (LDRS). In summary, it provides a one-time window to taxpayers to settle all excise and service tax (including additional levies & cesses) disputes right from audit/investigation stage till appeals pending before the Supreme Court with a relief varying from 40% to 70% (depending upon the prescribed situations). It also provides relief from interest and penalty on such tax dues, which has a significant bearing given the timeline of such disputes, besides immunity from prosecution. As stated in the Economic Survey 2019, arguably, the single biggest constraint to ease of doing business in India is our ability to enforce contracts and resolve disputes. Delays and pendency of economic cases takes a severe toll on the economy in terms of stalled projects, mounting legal costs, contested tax revenues and subdued investments. Such long drawn litigation plagues the already clogged judicial system of the country.

The FM unveiled LDRS with an objective to resolve excise and service tax disputes arising in the pre-GST period, and clear massive backlog of cases, improve administrative efficiency, which has the potential to unlock material sum of Rs. 3.75 trillion pending in litigations. As at the quarter ending March 2017 (as per Economic Survey 2018), a total of 1.45 lakh appeals were pending with the Commissioner (Appeals), CESTAT, HCs and the SC valued by the Department at 2.62 lakh crores, with majority of cases (and value) before the the Tribunal. This, of course, has further soared up over the last 2 years. Furthermore, both taxpayers and the Revenue have contributed to multiplicity in litigation on overlapping and recurring issues/demands over a period. There are several contentious issues before higher judicial fora that are yet to attain finality. Issues forming part of legacy matters include classification, valuation related, clandestine removal, place of removal, input credit, etc. This has choked the judicial system of the country, besides being a deterrent to the economy. Should these matters continue to be litigated in the ordinary course, it would take 8-10 years to achieve finality, besides piling up of fresh cases under the GST law. The guiding philosophy of LDRS is clearly to surmount past issues and start on a fresh note with the new law. The need to address the perils under the erstwhile laws, thus, cannot be over-emphasized!

Highlights of the Scheme: The scheme extends to the Central Excise Act, 1944 (or Central Excise Tariff Act, 1985), Service Tax Act (Chapter V of the Finance Act, 1994), and other central (additional) levies and cesses under 26 different statutes, all of which were subsumed into GST. Perhaps, Customs Law was kept away since it's a disparate law with border protection/regulation and trade facilitation objectives (and of course, its still in operation, unlike Excise and Service Tax). The salient feature of the scheme is that its scope covers all forums, including the Tribunals, High Courts and the Supreme Court.

The procedural mechanics of the scheme is as follows:

• Taxpayer files tax dues declaration online.
• A Designated Committee verifies the correctness of the declaration (except in the case of voluntary disclosures).
• On satisfaction, the Committee would issue a statement (for payment) within 60 days.
• In case of a mismatch (short-declaration), the Committee will issue a statement (for payment) within 30 days. After personal hearing of the taxpayer (optional), the Committee shall issue a statement (for payment) within 60 days.
• Taxpayer to pay the amount within 30 days of receipt of such statement.
• After payment verification, Taxpayer is issued a Discharge Certificate by the Committee.

Exception to the scheme are cases of erroneous refunds, matters before the Settlement Commission, cases involving convicted persons, voluntary disclosures under any enquiry, investigation or audit, and cases where the final hearing has been completed before any appellate forum. It is also interesting to note that any amount paid during an investigation or as pre-deposit can be adjusted against the declared dues, though any excess paid will not be refunded. Another feature is that no input tax credit can be utilized towards payment of such dues, and neither can the paid amount be claimed as input tax credit. The prohibition on utilization or availment of input tax credit is probably due to the absence of statutory provisions under the GST law. At the same time, the economic rationale behind such restriction may also be to realize maximum tax dues without any further benefit of credit adjustment to the taxpayer. Needless to say, all legal proceedings relating to the declaration shall terminate and any appeals pending shall be withdrawn/deemed to be withdrawn.

Historically, India has witnessed several tax amnesties both under direct and indirect taxation under popular tags such as Voluntary Disclosure of Income Scheme (VDIS) (Income Tax), Voluntary Compliance Encouragement Scheme (Service Tax), Income Declaration Scheme (Black Money scheme) and so on. Though the success rate of these schemes were relatively low (other than VDIS of 1997 & 2016), the Government was still able to recover undisclosed, untapped and blocked tax revenue. Interestingly, FM didn't introduce LDRS as an 'amnesty' scheme but a dispute resolution scheme, though the scheme is undoubtedly a 'tax amnesty' in letter and spirit! Perhaps, FM avoided using the term 'Amnesty' (in the speech) keeping in mind the Supreme Court guidelines (under VDIS, 1997 scheme) on amnesty, in general. In line with the guidance, critics would emphasise the demoralising effect of amnesty on honest taxpayers, extending a leeway to delinquent taxpayers to get away with truncated settlements without interest, penalty and prosecution. However, from an overall governance and 'ease of business' standpoint, FM's proposal stands as a frontrunner for swift closure of past cases.

An apparent feature of this scheme is that it extends only to the central levies, and not to State levies including Value Added Tax (VAT) and Central Sales Tax (CST). It is contingent upon the States to devise suitable schemes to address disputes. There is no credible government data on the quantum of disputes under state indirect taxes. Pertinent instances include recent amnesty schemes announced by Karnataka, West Bengal, Maharashtra and Gujarat, with other States currently deliberating upon introduction of similar schemes to close past assessments and reduce litigation.

The instant scheme as a part of the Government's tax reforms agenda is expected to ensure tax dispute certainty. Given the inimitable wide coverage of the scheme with potential to clear backlog of most pre-GST disputes, it is a pathbreaking measure. It is anticipated that taxpayers will weigh cost-benefits before opting. Likewise, taxpayers will take stock of their pending litigation and review the strength of their cases to make a call on plugging the settlement option decisively.

Bringing Global Financial Markets Home - The IFSC GIFT

This Article has been co-authored by Gouri Puri (Partner, Shardul Amarchand Mangaldas, Co ) and  Suyash Sinha (Senior Associate, Shardul Amarchand Mangaldas, Co).

Introduction

The idea to make India Inc. a global exporter of financial services was first mooted in 2007, by the Indian Government in the High Powered Expert Committee to make Mumbai an International Financial Centre, led by Percy Mistry[1]. However, no measures were taken to set-up an IFSC in the wake of the 2008 financial crisis. The Finance Minister, in his 2015 budget speech recognized that, “while India produces some of the finest financial minds, including in international finance, they have few avenues in India to fully exhibit and exploit their strength to the country's advantage. GIFT in Gujarat was envisaged as International Finance Centre that would actually become as good an International Finance Centre as Singapore or Dubai, which, incidentally, are largely manned by Indians.”

After mulling for several years, India finally set-up its first International Financial Services Centre (“IFSC”) at Gandhinagar, Gujarat in 2015 as part of a Special Economic Zone (“SEZ”). The objective was to tap into the burgeoning international financial services market that had proven to contribute immensely to the gross domestic product in countries such as Singapore, UK, US and Dubai. Notably, international financial centres contribute to economies through creation of jobs, enhanced tax revenue and have a multiplier effect in secondary sectors such as education, infrastructure, real-estate, telecommunications, and consumer goods etc.

The International Monetary Fund in its working paper on offshore financial centres, published in June 2000 has defined 'International Financial Centres' as large international full-service centres, with advanced settlement and payments systems, supporting large domestic economies, with deep and liquid markets where both the sources and uses of funds are diverse, and where legal and regulatory frameworks are adequate to safeguard the integrity of principal-agent relationships and supervisory functions. International Financial Centres, generally borrow short-term from non-residents and lend long-term to non-residents. 

Gujarat International Financial Tech-city (“GIFT”), India's first IFSC, was set up to facilitate overseas financial institutions and overseas branches / subsidiaries of Indian financial institutions to undertake financial services transactions that were hitherto carried on outside India.

In this article, we present a bird's eye view of the legal framework under which IFSC operates and the fiscal benefits it offers.

Key Features

The key features that make setting up units in an IFSC so attractive are:

-         Caters to customers outside the jurisdiction of the domestic economy, dealing with the flow of finance, financial products and services across borders from India, since IFSC units are treated as non-residents under RBI regulations.

-          IFSC permits undertaking transactions in any permitted foreign currency except Indian Rupee.

-          Ease of doing business

-          Numerous tax breaks to make Indian IFSC units globally competitive (discussed in detail in this article below)

-          State of the art infrastructure and technology

-          Round the clock transactions with 23.5 hours a day operational exchanges

-          Ease in dispute resolution with an overseas representative office of the Singapore International Arbitration Centre at GIFT city

Regulatory Framework

The SEZ Act, 2005 allows setting up of an IFSC in an SEZ after approval of the Central Government[2]. It also empowers the Central Government to empower regulatory bodies to prescribe the requirements for setting up and the terms and conditions of the operation of units in an IFSC[3]. At present, IFSC units are governed by individual sectoral regulators [Reserve Bank of India (“RBI”), Securities Exchange Board of India (“SEBI”), and Insurance Regulatory and Development Authority of India (“IRDAI”)], that have issued separate guidelines for setting up and operation of IFSC units with specific carve-outs from mainland provisions.

For ease of set-up of IFSC unit, the Ministry of Finance (SEZ division) has introduced a consolidated application form for setting up services units in IFSCs[4]. As per the guidelines issued in this respect, IFSC units are permitted to undertake, inter alia, following activities subject to certain prescribed conditions:

However, taking cue from more mature regulatory structures of IFSCs in Dubai, Singapore and London, India realized the need to bring coherence in the IFSC regulatory regime creating further ease of doing business to attract the progressive landscape of global financial services back home. To this end, the proposal for creating a unified regulator to oversee all financial services in the IFSC was tabled in the Rajya Sabha on February 12, 2019[5]. While the unified regulator (IFSC Authority) is yet to be approved and notified by the Government, the fate accompli of such a change will be the harbinger of a greater fillip to attract global financial giants to Indian IFSCs.

Tax Breaks

IFSCs also bring to the table fiscal benefits such as tax breaks in the form of exemption from goods & services tax[6], customs duties, securities transaction tax[7](“STT”), commodity transaction tax, stamp duties[8], etc.

On the income-tax front, the Income-tax Act, 1961 (“IT Act”) provides the following tax incentives:

• Long-term capital gains : Exemption from long-term capital gains tax arising from transaction undertaken in foreign currency on a recognized stock exchange located in an IFSC irrespective of payment of STT on the same;

• Short-term capital gains : Concessional short-term capital gains tax rate of 15% is available on transactions undertaken in foreign currency through a recognised stock exchange located in an IFSC, even where no STT is payable.

• Further, the transactions in foreign currency in the following assets by a non-resident on a recognized stock exchange located in any IFSC are also exempt from capital gains tax:

           -        Bond or Global Depository Receipt,

           -        Rupee Denominated Bonds of an Indian company;

           -        Derivatives; and

           -        Certain other notified securities

The Finance Bill, 2019 (“Bill”) proposes to extend the benefit of such tax-neutral transfer to transfer of securities by a Category III AIF (all unit holders of which are non-residents).

• Minimum Alternate Tax (“MAT”) : A unit located in IFSC and deriving its income solely in convertible foreign exchange, is chargeable to MAT at the rate of 9% (plus applicable surcharge and cess), for existing as well as newly set-up IFSC units as against 18.5% (plus applicable surcharge and cess). Even existing IFSC units can avail a lower MAT rate of 9% (subject to fulfilment of other conditions). Similarly, an alternative minimum tax (which is applicable to firms, LLPs, AOPs etc.),  at par with the lower 9 % MAT rate has been provided.

• Dividend Distribution Tax (“DDT”) : Currently no DDT is applicable on dividend distributed (out of current year profits), in case of a company being a unit located in an IFSC, deriving income solely in convertible foreign exchange, either in the hands of the company or the person receiving such dividend. The Bill, proposes to extend the exemption from DDT on distributions paid out of accumulated profits as well.

• Tax exempt interest payments from IBUs : Interest paid by an off-shore baking unit on deposits/ borrowings made on or after April 1, 2005 by a non-residents is tax exempt[9]. The Central Board of Direct Taxes has clarified that IBU's will be entitled to such benefits as well.[10]

• Profit Linked Tax Holiday: Currently, IFSC units can avail an exemption of 100% of the income for its approved business for the first 5 consecutive assessment years commencing from the year in which permission from RBI, SEBI or IRDAI, as the case may be is obtained, and 50% of such income for the next five consecutive assessment years.

The Bill proposes to provide a 100% deduction for any 10 consecutive assessment years out of a block of 15 assessment years, beginning with the year in which permission/ registration to operate the unit is received from RBI or SEBI or IRDAI, as the case may be, at the option of the taxpayer.

Additionally, the Bill proposes the following tax benefits:

• To facilitate external borrowing by units located in an IFSC, interest income payable to a non-resident in respect of monies borrowed on or after September 1, 2019 is proposed to be tax exempt.

• To incentivize relocation of mutual funds in IFSCs, no additional income-tax shall be chargeable in respect of distributions made on or after September 1, 2019, by such mutual fund (all unit holders of which are non-residents) out of income derived from transactions undertaken on a recognized stock exchange located in an IFSC.

Conclusion

Notably, the Central Government has mustered tremendous efforts to make both - the regulatory and tax regime attractive, for global financial services businesses to set up shop in India and operate with ease. The proposed measures, including a single regulator & tax incentives (both direct and indirect) for IFSCs are sure to bolster the growth of IFSCs in India. Additionally, the Government will need to build investor confidence through consistency, transparency and clarity in policy measures, both in the regulatory and tax regimes.

[1] Former World Bank Economist

[2] Section 18(1) of the SEZ Act, 2005

[3] Section 18(2) of the SEZ Act, 2005

[4] Form-F under Rule 17 of SEZ Rules, 2006

[5] The International Financial Services Centres Authority Bill, 2019

[6] Central Board of Indirect Taxes Notification No. 9/2017 dated June 28, 2017

[7] Section 98 of the Finance (No. 2) Act, 2004

[8] As per State Government policy

[9] Section 10(15)(viii) of the IT Act                           

[10] CBDT Circular 26/2016 dated July 4, 2016

Finance Bill 2019: Proposals Relating to Charitable Entities

This Article has been co-authored by CA Chaitee Londhe (Sr. Manager - Direct Tax, Gokhale & Sathe Chartered Accountants)

India has always recognized the role of voluntary non-profit making or charitable organizations in society. The government has made efforts to provide a conducive legal and fiscal framework, to promote the charitable organizations committed to social welfare. This includes tax exemption granted to charitable institutions under the Income Tax Act.

Though we have various public charitable organizations established and functioning from different parts of the country, there is no central legislation governing the regulation and functioning of these organizations. Different legislations have been enacted by different states in that regard. For example, in Maharashtra, registration and functioning of the public charitable trusts is governed by the offices of Charity Commissioner under the Bombay Public Trusts Act, 1950. If the charitable entity has specific objectives, then regulations relating thereto would apply. Obviously, these differ from state to state.

Under the Income Tax Act, registration under section 12AA (erstwhile section 12A) is the fundamental requirement for availing of the exemption granted under section 11. The conditions for granting such registration and provision for cancellation of registration already granted have been laid down in the same section. Until recently, activities and functioning of the charitable organizations were not a subject matter of a very stringent scrutiny for the purpose of granting registration or exemption under the Income Tax Act. However, the trend from the past few years would suggest that the era of looking at charitable organizations leniently has ended, and going forward, these organizations will have to strictly establish their eligibility to claim various incentives under the Act and failure to do so will lead to severe consequences. This is possibly on account of the tax department's view that charitable trusts are used as vehicles of tax planning / avoidance. While this may be true in some cases, these are exceptions and not the rule. Over the past few years, there has been a significant increase in the number of cases wherein, registration under section 12A/12AA has been withdrawn for the wrong reasons. Though in many such cases, the cancelation is ultimately held to be unlawful by the courts, the trend is indicative of the approach of the department.

This drastic change in approach towards the charitable organizations is also evident from various amendments that have been brought in recently; the last major amendment being introduction of Chapter XII-EB by Finance Act 2017, to provide for taxation of “accreted income” of charitable organizations in the event of their treatment as having been converted into a non-charitable form. The devastating effect is the net worth of the charitable entity being subjected to tax. According to the provisions of the said chapter, one of the events which would be deemed as conversion into non-charitable form is cancellation of registration under section 12A/12AA.  

It is in light of these provisions, that significance of the recent amendments proposed in section 12AA by the Finance Bill 2019 must be understood.

Until now, for grant of registration under section 12A/12AA, the only aspects which were required to be looked into by the Commissioner were, the charitable nature of objects and genuineness of the activities of the organization. With effect from 1st October 2004, a power to cancel the registration already granted has been given to the commissioner, if subsequent to the registration, activities of the trust are found to be non-genuine or not in accordance with its objects. Further, sub-section (4) was inserted in section 12AA with effect from 1st October, 2014 to provide that non-eligibility to claim exemption on account of violation of provisions of section 13(1) would also be a ground for cancelation of registration already granted.

In addition to the above, Finance Bill 2019 proposes to amend existing sub section (1) of section 12AA to impose another condition for grant of registration, that the commissioner should satisfy himself about compliance of such requirements of any other law for the time being in force by the trust or institution as are material for the purpose of achieving the objects. Similarly, amendment is also proposed in sub-section (4) of section 12AA to provide that if, the trust or institution has not complied with the requirement of any other law and the order, direction or decree, by whatever name called, holding that such non-compliance has occurred, has either not been disputed or has attained finality, then the registration may be canceled.

It is important to note that the phrases used in the proposed provisions like “such requirement of any other law” or “as are material for the purpose of achieving the objects” or “order, direction or decree” are capable of extremely subjective interpretation, and considering the present approach of the tax officers, this possibly would open the floodgates of litigation. 

It should be noted that while a final order, direction or decree holding that a non-compliance has occurred is necessary for cancelling the registration on ground such non-compliance, aspects like authority passing such order or materiality / consequences of such order have not been laid down in the provision. As a result, on account of lack of any objective criteria, the tax officers will have arbitrary powers to invoke the said section on account of insignificant non-compliances.

Another important aspect which must be noted is that, whereas an order/direction/decree must necessarily exist for cancelation of registration on the ground of non-compliance,  while granting registration, it is the commissioner himself, who is required to scrutinize the compliance by the organization of requirements of any other laws. Given the variety and complexity of laws and regulations this is virtually impossible.

As stated earlier, the charitable organizations in India are governed by various state laws and are therefore governed by different rules and regulations. It seems highly unreasonable to expect from an income tax authority to be able to comprehend provisions of different legislations applicable to an organization. To illustrate, educational / medical institutions in Maharashtra are subject to regulations which themselves undergo changes from time to time. Further it is a well-established proposition of law that registration does not give an automatic right to exemption under section 11. The claim itself is subject to verification at the assessment stage which itself is subject to a revisionary jurisdiction 

There are instances where, certain conditions imposed under the laws governing charitable organizations, are practically difficult to comply with. In such cases, even though a direction may be issued by the concerned authority holding that a non-compliance has occurred, the same may subsequently be regularized by the same authority after having regard to the merits of the case. However, in view of the proposed amendments, it is possible for the revenue to cancel registration under section 12AA on account of such minor infractions. Another example of the practical issues likely to be faced by these organizations could be the cases where infraction of law is involuntary and on account of unauthorized actions of one of the trustees. In such cases, though the non-compliance of law is attributable to actions of a single individual, trust may be penalized by way of cancelation of registration u/s 12AA, irrespective of existence of remedy available to the trust against such defaulting person.

We have seen examples in the past of hyper-technical views being adopted by the revenue authorities and to some extent by the judicial forums while interpreting provisions relating to charitable organizations. For an instance, readers may recollect a decision of Hon'ble Kerala High Court (226 ITR 211) wherein, exemption in respect of entire income of a trust was denied by invoking provisions of section 13(1) on the ground that a refrigerator purchased by the trust was kept at the residence of one of the trustees for some period of time as the building of the trust was not ready. Likewise, there are instances of registration being canceled on account of applicability of proviso to section 2(15) or other insignificant grounds, where cancelation of registration is ultimately held by the courts to be unlawful. 

As stated above, the gravity of the above issues needs to be understood in the light of provisions of chapter XII-EB which are triggered on cancelation of registration. The consequences of application of these provisions are so harsh, that the same can not only affect the financial position of the organization, but may threaten its existence itself.

Considering that there already is a sufficient mechanism in place under the existing provisions of Income Tax Act to deny exemption to charitable organizations if the income or property of such organization is not applied for charitable purposes; the proposed amendments in their current form, which have drastic consequences are wholly unnecessary. At a time when the Finance minister has shown an innovative and pragmatic approach while contemplating Social Stock Exchange for social enterprises, these proposals are not in sync with it. Unless some objective safeguards are brought in, these proposals may lead to completely avoidable litigation, adversely affecting genuine organizations.

Let us hope that the authorities will show the requisite empathy and kindness that charitable organizations richly deserve!.

Amendment to Section 115QA as Proposed by Finance (No 2) Bill 2019 - A Costlier Affair for Buy Backs by Listed Companies !

This Article has been co-authored by CA Bhavik Shah (G. K. Choksi & Co., Chartered Accountants)

1. Vide Finance Act 2013, Section 115QA was inserted to Income Tax Act, 1961 as an anti-abuse provision to curb the practice of unlisted companies resorting to buy-back of shares instead of making payment of dividends. This was primarily done to avail tax arbitrage as tax rate for capital gains was lower than the aggregate of the taxes payable on Dividend in the hands of the company as well as the shareholder. This route was extensively used by certain closely held companies having investment from Mauritius and Singapore, since Indian tax treaty with them exempted capital gains tax. Through section 115QA insertion, unlisted companies were mandated to make additional payment of 20% (excluding cess and surcharge), here in after referred as Buy Back Tax - 'BBT'. Correspondingly, section 10(34A) was also inserted to statute as to make that income exempt in the hands of shareholders who are participating in buy-backs.

2. However, Buy Back mechanism gained popularity amongst the listed companies since SEBI introduced rules allowing buyback of shares through the stock exchange. Long Term Capital Gains in the hands of the shareholders remained tax exempt and the HNI shareholders receiving dividend above ten lakhs saved an additional tax of 10 percentage payable u/s 115BBDA of the Income Tax Act. At the same time the company used to save Dividend Distribution Tax u/s 115-O. This route was used as a substitute to distribute surplus profits under the guise of Buy back of shares.

3. Therefore, to plug the above tax leakage it has been proposed in the bill to amend section 115QA so as to cover listed companies as well.  It has been proposed that listed companies carrying out Buy Back on or after 5th July 2019 would be liable to pay additional income tax at the rate of 20 percent (excluding cess and surcharge). Correspondingly, section 10(34A) has also been proposed to be amended in as much as to give effect that such income arising on buy back of listed company share will not be taxable in the hands of shareholders from 5th July 2019 and onwards. Memorandum explaining Finance Bill describes the intention of the government to plug the tax arbitrage arising between dividend and income arising from buy back, whether said purpose have been achieved or not, will be discussed in later part of this article.

3. Impact of above amendment on Buy back offers of listed company which are under way as on 05th July 2019 :

This amendment undoubtedly has a major impact for the listed companies whose buy back offers are under way as on 5th July 2019, as said listed companies would not have foreseen the possibility of taxation at their end first while floating a tender for buy back of share and determining the price per share for buy back. The Tax liability u/s 115QA is with immediate effect from 5th July 2019, however now for several commercial as well as regulatory reasons, companies may not be in a position to change the offer price for buy back to pass on the BBT to the shareholders. Thereby, additional tax liability placed on listed companies of 23.96%; may turn out to be additional cost for those companies whose buy back offers are at an advanced stage of conclusion.

4. Section 115QA starts with its non-obstante clause over the entire Act's provision, providing for levy of additional tax at the rate of 20% (23.96% inclusive of surcharge and cess ) of the 'distributed income' on account of buy back. The term 'distributed income' has been defined at Explanation 2 to Section 115QA to mean ' the consideration paid by the company on buy-back of shares as reduced by the amount received by it for issue of such shares to be determined in the prescribed manner.' The amount received on issue of shares has to be determined as per Rule 40BB of the Income Tax Rules. In Rule 40BB, different 11 categories has been defined as per which the 'amount received by the company in respect of buy - back of share' needs to be determined. Now, on such determined distributed income listed companies will have to pay BBT u/s 115QA and in the hands of shareholder's same will not be taxable.

6. Offer for Sale (OFS), as we all know, is a method used to transfer and distribute ownership of a company from promoters/ Investors to other investors over the stock exchange. One also need to evaluate a typical scenario in the case of a company which has gone in listing initially through OFS now undertakes buy back of shares. It is optional on the promoters whether  to participate in the proposal for Buy Back under the existing regulations. If a decision is taken whereby the promoters / promoter group companies do not participate then the payment made towards buy back of shares cannot be compared to dividend distribution. Assuming in such case, that the promoters / investors have sold shares directly to public at large (suppose at Rs. 100 per share, which were originally subscribed by the promoters/investors at Rs. 1) and now, if such company is proposing to buy back the shares (suppose at Rs. 150 or at Rs. 80). In such case what will be the distributable income on which BBT would be required to be paid by such listed company under proposed amendment to section 115QA. The present Rule 40BB does not cover such a typical situation. Sub rule 2 to 40BB rule provides for considering the actual price (including premium if any there) which has been actually received by the company. On strict interpretation of the Section 115QA r.w.r. 40BB, in such a case, as the company would not have received any funds at the time of offer for sale, the company would be subject to additional tax @23.36% on an amount of Rs. 149/Rs.79 per share. Although, the investor would be effectively earning profit of Rs.50 (Buy back at Rs.150) or incurred losses of Rs. 20 (Buy Back at Rs.80); the company would be called upon to pay tax on a substantially higher amount i.e. on 149/Rs. 79 per share. Clarity on such typical situation case should be brought by CBDT in rule 40BB, otherwise buy-back of share in such a situation will lead to a costlier affair.

6.  In consequent to proposal to amend section 115QA, the question now arises is to whether any tax arbitrage is still possible or not. Below chart provides for the total tax rate suffered in the case of dividend vis-a-via buy back offer for different categories of shareholders:

** NR may be liable to pay Capital Gain in their respective jurisdiction. Whether or not they would be eligible to claim BBT paid by company as credit needs to be evaluated on case to case basis.

In view of the above table it appears that Buy Back would still remain an option worth considering, at least till the next budget is presented !

Budget 2019 - Strategic Boost to IFSC

 The article has been co-authoered by Vidya Mallya (Senior Manager, Deloitte Haskins and Sells LLP).

Gujarat International Finance Tech-city (GIFT) SEZ, is India's first International Financial Services Centre (IFSC) under the Special Economic Zone Act, 2005 (“SEZ Act 2005”). GIFT IFSC is a Multi Services Special Economic Zone and commenced its business in April 2015.

Number of SEZ units operationalized: 66

Average daily turnover on international exchanges: US$ 1.8 bn

Number of employment generated in GIFT City: 9000+

IFSC Banking Business as on 31st March, 2019: US$ 18 bn

IFSC Insurance Business Sum Insured: US$ 30 bn

Source: http://giftsez.com/

Policy Initiatives in the Budget 2019

Leverage the business opportunities of the IFSC for aircraft leasing and financing from India. Government will implement the essential elements of the regulatory roadmap for making India a hub for such activities.

To facilitate on-shoring of international insurance transactions and to enable opening of branches by foreign reinsurers in the IFSC, it is proposed to reduce Net Owned Fund requirement from INR 5,000 crore to INR 1,000 crore of foreign reinsurance companies setting up branches in IFSC.

Present direct tax benefits to a unit in IFSC

• Deduction of 100 percent of income for 5 consecutive assessment years (AY) beginning with the AY relevant to the previous year in which necessary permission was obtained, and thereafter deduction of 50 percent of income for 5 consecutive assessment years.
• Reduced MAT rate of 9 percent
• Tax not required to be withheld from interest paid by IFSC on deposits made by non-resident or on borrowings from non-resident.
• No dividend distribution tax shall be chargeable in respect of the total income of a company, being a unit of an IFSC, deriving income solely in convertible foreign exchange, for any assessment year on any amount declared, distributed or paid by such company, by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2017, out of its current income, either in the hands of the company or the person receiving such dividend.
• Transfer of a capital asset being a bond or GDR or rupee-denominated bond of an Indian Company or a derivative, made by a non-resident on a recognised stock exchange located in any IFSC (where consideration is paid or payable in foreign currency), shall not be regarded as taxable transfer.

Other benefits include:

·         Commodity transaction tax waived off

·         Securities transaction tax waived off

·         Indirect tax benefits

Direct Tax Proposals in the Union Budget

• Presently as per section 47(viiab) of the Act, any transfer of a capital asset, being bonds or Global Depository Receipts, or rupee-denominated bond of an Indian company, or derivatives by a non-resident on recognised stock exchanges, in the IFSC is treated as not a taxable transfer. It is proposed to include other securities as is notified by the Government to be eligible for such exemption. Further this relief is proposed to be extended to Alternative Investment Fund (AIF) Category III, where all the unit holders of such AIF are non-resident, subject to fulfilment of specified conditions. The aforesaid amendments shall be effective from assessment year 2020-21.
• Any income by way of interest payable to a non-resident by a unit located in IFSC, in respect of monies borrowed by it on or after 1st day of September, 2019, shall be exempt. The above amendment shall be effective from assessment year 2020-21.

{Presently there is no withholding of tax on such interest payments - However the exemption from tax is provided only with respect to money's borrowed on or after 1 September 2019. This may lead to litigation and should be amended retrospectively considering the volume of the banking transactions.}

• To facilitate distribution of dividend by companies operating in IFSC, it is proposed that any dividend paid out of accumulated income derived from operations in IFSC, after 1st April 2017, shall also not be liable for tax on distributed profits. This amendment shall be effective from 1 September 2019.
• No additional income-tax shall be chargeable in respect of any amount of income distributed, on or after the 1st day of September, 2019, by a Specified Mutual Fund of which all the unit holders are non-residents out of its income derived from transactions made on a recognised stock exchange located in any IFSC.
• Profit linked deduction to be increased to 100 percent for any ten consecutive years under section 80LA of the Act. A unit in IFSC, at its option, may claim the aforesaid deduction for any ten consecutive years out of fifteen years beginning with the year in which the necessary permission was obtained. The above amendment shall be effective from assessment year 2020-21.
• Section 115A of the Act provides the method of calculation of income-tax payable by a non-resident (not being a company) or by a foreign company, where the total income includes any income by way of dividend (other than referred in section 115-O), interest, royalty and fees for technical services etc. Section 80LA, provides for deduction in respect of certain incomes to a unit located in an IFSC. However, sub-section (4) of section 115A, prohibits any deduction under Chapter VIA which includes section 80LA.

With effect from assessment year 2020-21, the provisions of section 115A(4) shall not apply to a deduction allowed to a unit in an IFSC centre under section 80LA. So branch of non-resident entities should be eligible to claim deduction under section 80LA of the Act.

These are major tax reforms and policy framework to boost the growth of the IFSC. These measures will help achieve the vision of the Hon'ble Prime Minister Mr. Narendra Modi to make GIFT IFSC as an international hub for financial services activities.

Section 276CC - Wilful Failure to Furnish Returns of Income - A Few Thoughts Relevant

1. Section 139 requires a 'Person' under the Income-tax Act,1961 to file a Return of Income (ROI) in relation to the income for which the person is assessable or in relation the income of any other person in respect of which he is assessable. Such a ROI is required to be filed voluntarily by the specified due date as prescribed.

2. In respect of a person who has failed to furnish a ROI by the due date prescribed under the Act, the AO can invoke the provision of clause (i) of sub-section (1) of section 142 or in respect of a non-filer by issue of notice under section 148 calling for a ROI within the time prescribed in the Notice. The power to call for a ROI consequent to a search u/s 132 or requisition u/s 132A is provided under section 153A.

3.  A notice requiring a person to furnish a ROI for an assessment year can be termed as non-voluntary compliance for the sake of convenience in contrast to a voluntary compliance under section 139(1).

4.  A person can be proceeded against for wilful failure to furnish a ROI under section 276CC of the Act. Such proceedings can result in punishment by way of imprisonment and fine. The type of imprisonment and the term of imprisonment is linked to the tax that would have been evaded by such person if the failure had not been deducted.

5. The failure contemplated in respect of wilful failure to furnish a ROI required to be furnished by a person is of the following types:

a. Failure to furnish ROI within the due time u/s 139(1);

b. Failure to furnish ROI within the due time as mentioned in the Notice calling for a ROI issued under clause (i) of sub-section (1) section 142 or section 148 or section 153A as the case may be;

The section uses the word 'due time' in preference to due date which is mentioned in section 139(1) of the Act. Due time includes 'due date' and due time is more exhaustive as it applies to the multiple scenarios as mentioned in clause (a) and (b) above.

6. Proviso to section 276CC mentions that a person, other than a company, cannot be proceeded against for failure to furnish a ROI within the due time under section 139(1) in either of the following two situations:

a) If such a person has furnished a ROI before the end of the AY; or

b) If the tax payable on the total income determined on regular assessment, as reduced by the advance tax, if any, paid, and any tax deducted at source, does not exceed three thousand rupees.

7.  As may be evident that the protection available to a person in terms of tax payable being below the threshold limit of Rs.3000 is applicable only where the ROI is required to be furnished voluntarily u/s 139(1) and which was not eventually filed before the end of the assessment year and determination of the tax payable through a regular assessment was completed by the AO.

8. Regular assessment is defined in section 2(40) of the Act. “Regular assessment" means the assessment made under sub-section (3) of section 143 or section 144. It is common knowledge that an assessment cannot be initiated unless a case is selected for scrutiny either under CASS (which requires essentially a ROI) or selected manually with the approval of the higher authorities as per the extant instructions at the relevant point of time. Either way a regular assessment u/s 143(3)/144 cannot be completed in the absence of a ROI without initiating the proceedings requiring the taxpayer to furnish a ROI. The only recourse available to the AO  then is to issue notice under clause (i) of section 142(1) of the Act. However, such a ROI has to be furnished within the due time prescribed in the notice under section 142(1). Otherwise the second failure may constitute a separate cause of action which is not protected by the proviso to section 276CC of the Act.

9. It is therefore clear that since the proviso is applicable only to a case of failure to furnish a ROI u/s 139(1) voluntarily by the due date for an assessment year in respect of which tax payable has been determined in a regular assessment u/s 143(3) or 144, which is not possible without issue of a notice u/s 142(1). It is also relevant to note that the assessment u/s 147 for the first time is not a regular assessment and an order of assessment u/s 147 is a stand alone order appealable u/s 246A of the Act in addition to an order of assessment u/s 143(3)/144 which is listed separately.

10. In short, if one were to go by the strict interpretation of the proviso, the exemption from prosecution by way threshold limit of tax payable determined on a regular assessment in a case of a no ROI is only possible where the AO completes a regular assessment by  resorting to section142(1) requiring the assessee to furnish a ROI within the due time and the taxpayer has to ensure compliance by furnishing a ROI within the due time mentioned in the Notice.

11. Therefore, the only way a non-corporate tax-payer can save himself from prosecution is either to furnish a ROI before the end of the relevant AY or in the event of a prompt received from the AO in the form of Notice u/s 142, by furnishing the ROI in due time mentioned in the notice under clause(i) to section 142(1) of the Act.

12. Finance bill (2) of 2019 seeks to amend section 276CC as under:

Line 35:

Amendment of section 276CC

65. In section 276CC of the Income-tax Act, in the proviso, in clause (ii), for sub-clause (b), the following sub-clause shall be substituted with effect from the 1st day of April, 2020, namely: --

 “(b) the tax payable by such person, not being a company, on the total income determined on

regular assessment, as reduced by the advance tax or self-assessment tax, if any, paid before the expiry of the assessment year, and any tax deducted or collected at source, does not exceed ten thousand rupees.”.

13. As per the proposed amendment, credit for self-assessment tax is available if it is paid before the end of the relevant assessment year, which is in addition to the credit available by way of Advance tax and TDS.

14. To sum up, wilful failure to furnish a ROI within the due time under section 139(1) can result in prosecution of the non- corporate tax payer, if no ROI is furnished before the end of the relevant AY, unless the taxpayer makes good his default by furnishing a ROI within the due time mentioned in the Notice u/s 142(1) of the Act issued by the AO requiring him to furnish the ROI on or before the due time mentioned in the notice. Any further delay may result in a separate cause of action under section 276CC, for which the AO can proceed against the taxpayer independently in which case, the saving clause of 'tax payable' not exceeding the threshold limit would be non-operative.

Taxing Gifts to Non-Residents

Finance (No.2) BILL, 2019 (“Finance Bill”) proposes to tax gifts to non-residents by an amendment to Sec 9 of the Income Tax Act (“the Act”) that scopes in any sum referred to in clause (x) of sub-section (2) of section 56, (any money paid without consideration or any property situate in India transferred by a person resident in India to a person outside India without consideration or at less than fair market value) as Income deemed to accrue or arise in India.

Clause (x) of section 56(2) is an anti-abuse provision to prevent receipt of money or property without consideration or for inadequate consideration, by way of purported gifts; with certain exceptions for genuine circumstances carved out. It applies to any such receipt or transfer between any persons. 

As observed by the memorandum to the Finance Bill, clause (x) of section 56(2) when applied to prevent any sum of money paid or transfer of property situate in India by a resident to a non-resident, without consideration at less than fair market value, was disputed and it was claimed that there is no actual or deemed receipt or accrual or deemed accrual  in India to the non-resident; an essential condition under Section 5 for taxing the non-residents. 

The author deals with the proposed amendment looking at: historical taxation of gifts, overview of clause (x) of section 56(2), potential tax conundrum when a receipt is taxed as an accrual, treaty situation and potential conflict with Chapter X. 

Historical overview of taxation of gifts:

Gift-tax Act 1958, which was in force till 30-09-1988, levied gift tax on the donor. The main reason for abolishing gift tax was that it neither yielded any substantial revenue nor could prevent the abuse. With no gift tax and exemption from chargeability under the Income Tax Act, gifts virtually remained untaxed until a deeming provision in clause (v) of section 56(2) was inserted by Finance Act, 2004, w.e.f 01-04-2005, to provide that any sum of money received by an assessee being individual or HUF exceeding ₹ 25,000/- will be deemed to be income under the head “Income from Other Sources”. Certain exceptions, like receipt from a relative or on the occasion of marriage etc., were provided. Act was amended w.e.f from 01-04-2007 and a new clause (vi) was inserted with an enhanced limit of Rs 50,000. 

A new clause (vii) was inserted vide by Finance (No.2) Act,2009 w.e.f 01-10-2009 to further include under the deeming provision a receipt of immovable property without consideration. The Act was further amended vide Finance Act, 2010 w.e.f 01-06-2010 and a new clause (viia) was inserted to also tax under the deeming provision a receipt by a firm or company (not being a company in which public are substantially interested) of shares of a company (not being a company in which public are substantially interested) without consideration or at less than fair market value. Further vide Finance Act, 2013 w.e.f 01-04-2013 a new clause (viib) was inserted for taxing premium on issue of shares in excess of fair market value of such shares. 

A significant amendment was made vide Finance Act, w.e.f 01-04-2017, suppressing all the deeming provisions except clause (viib) and a new clause (x) was inserted. Currently clause (viib) and clause (x) are in force and deem certain issue of shares or receipt of money or property as income under section 56. 

Overview of clause (x) of section 56:

Clause (x) deems as income the following types of anti-abuse transactions:

• Money in excess of Rs 50,000 received by any person without consideration 
• Receipt by any person of property without consideration / inadequate consideration 

Property is defined exhaustively and includes the following immovable and other movable properties only. 

• Immovable property being land or building or both;
• Shares and securities;
• Jewellery;
• Archaeological collections;
• Drawings;
• Paintings;
• Sculptures;
• Any work of art;
• Bullion;

It is pertinent to note that the term 'consideration' is neither defined under the Gift-tax Act nor under the Income Tax Act, and it is a settled position that it must carry the meaning assigned to in section 2(d) of the Indian Contract Act, 1872, which reads as under:

“When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise….”

Consideration is said to be inadequate for an immovable property, if the consideration is less than the stamp duty value of the property and the difference between the stamp duty value and consideration is higher of Rs 50,000 or 5% of consideration. In such a case the amount deemed to be income is the difference between stamp duty value and the consideration. Where the immovable property is received without any consideration and the stamp duty value is in excess of Rs 50,000; the stamp duty value is deemed as income in the hands of the recipient. 

Similarly, for other movable property whose fair value exceeds Rs 50,000, is received without consideration, the entire fair market value is considered as deemed income in the hands of the recipient; in the case of inadequate consideration the difference between fair market value and consideration is deemed to be income of the recipient.

Further it is provided that where the date of agreement and date of registration are different the stamp duty value as on the date of agreement should be considered subject to consideration being wholly or partly paid on or before the date of agreement. 

Clause (x) of section 56(2) provides for exemption in certain genuine circumstances such as from a relative or on the occasion of marriage or under a will or inheritance or in contemplation of death or between a holding company and its wholly owned Indian subsidiary or between a subsidiary company and its 100% Indian holding company.

Tax conundrum of taxing receipt on accrual basis:

The proposed amendment by Finance Bill attempts to tax in the hands of non-resident any deemed income dealt by clause (x) of section 56(2) as income deemed to accrue or arise in India i.e. chargeable to tax u/s 5(2)(b). 

Clause (x) of section 56(2) is taxation on receipt of certain money or property, it is not taxation on accrual. 

Let's consider a simple case of a gift of immovable property situate in India by a resident in favor of non-resident; executed and accepted outside India. No income is received in India or accrued in India to the non-resident as gift is executed and accepted outside India and hence no income is chargeable to tax u/s 5(2). To avoid such non-taxation the Finance Bill attempts to bring the same u/s 9 i.e. income deemed to accrue or arise in India. However, the same may still not be taxed on accrual basis (when a deed was accepted), as under clause (x) of section 56(2) income is chargeable on receipt basis. Under the Transfer of Property Act, unless a gift deed of immovable property is registered the title does not pass to the donee. In short, for an income to fall u/s 56 there must be a receipt, and even if income is said to accrue at a prior time, it cannot be brought to tax until it is received. 

The Finance Bill brings to tax only property situate in India. In the case of movable properties (other than land or building or shares and securities) potential disputes can arise. For example, jewellery and paintings taken outside India by the Resident Donor and gifted to a non-resident donee without consideration or inadequate consideration (say a non-profit or charitable organization); vide a gift deed executed and accepted outside India. The recipient may still escape tax as the property is not situate in India when the gift was received. 

Treaty situation:

The memorandum to the Finance Bill rightly emphasizes that in treaty situation, the relevant article of applicable DTAA shall continue to apply. 

Two moot questions arise in a treaty situation:

• Whether deemed income under clause (x) of section 56(2) is an income under treaty as well?
• What is the relevant article for allocation of taxing rights?

Tax treaties are concerned with the allocation of taxing rights between the contracting states and facilitate avoidance of juridical double taxation by classifying items of income (Ex: business profits, dividends, interest, royalties, other income and capital). The income classification under the DTAA should not be confused with types of income under the domestic law. 

Article 21 OECD and UN model tax convention deal with “other income” i.e. income that is not otherwise dealt with specifically under the other articles of the convention. The actual text of Art 21(1) of OECD and UN MTC read as under:

“Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.”  

This is a catch-all Article and provides a general rule relating to income not dealt within the foregoing Articles of the Convention. The income concerned is not only income of a class not expressly dealt with but also income from sources not expressly mentioned. [OECD Commentary to para 1 of Article 21]

Clearly OECD commentary considers that Article 21 applies to any source of income arising under domestic law and not expressly dealt by the other Articles of the treaty.  India has expressed no reservations on Article 21. 

Article 21 applies to an income that arises wherever (third country as well) and is not dealt by other articles. The property referred in clause (x) of Section 56(2) are capital assets and are dealt by the tax treaty under Article on capital Gains. This can give rise to some challenges in taxing the deemed income: Can it be said that “inadequate consideration” is not dealt by Article on Capital Gains and hence Article 21 would not come into play?  Is inadequate consideration a separate source of income altogether and hence other income Article would apply? Whether a static interpretation should be given to Article 3(2) of the tax treaty (terms not defined: Income)? 

Under OECD MTC sole right is given to resident country. However, UN MTC Article 21(3) permits source country to tax the other income if it arises in source country, which reads as under 

“Notwithstanding the provisions of paragraphs 1 and 2, items of income of a resident of a Contracting State not dealt with in the foregoing Articles of this Convention and arising in the other Contracting State may also be taxed in that other State.”

India has signed double tax avoidance agreements with 94 countries. The allocation rights can be segmented as under:

• Exclusive right to tax other income to resident country - 5 countries 
• Exclusive right to resident country with limited right to source country to tax lotters, crossword puzzles, races, card and other games - 39 countries
• Source country permitted to tax other income - 46 countries
• No other income article - 4 countries

As noted by memorandum to the Finance Bill, the treaty exemption for 48 countries would override and India would still not be able to tax deemed income under clause (x) of section 56(2) arising to the residents of these countries. 

Potential conflict with Chapter X:

Does the proposed amendment by Finance Bill conflict with the transfer pricing regulations? A simple case of share transfer is analyzed below for examining any such conflict. 

A ltd a resident of India transfers its shares in B Ltd (wholly owned subsidiary in India) to F Ltd, a group entity resident of USA. The value at which the shares are transferred is at arms' length and as per FDI guidelines; but less than fair market value u/s 56 as determined under Rule 11 UA (which considers the book values). Can there be an income in the hands of F Ltd under section 56(2)? 

Where the transaction is at arms' length u/s 92 C and no adjustment is made by the source country, the income is dealt by Article on capital gains and as well as Article 9 (Associated Enterprise); and hence in the view of the author residual article 21 i.e. other income cannot be applied. Would it be different if F Ltd is an unrelated party and only Article on Capital Gains deals with the income?

(views are personal).

Non-Withholding of Tax on Payments to Non-Resident - Whether Applies Retrospectively?

This article has been co-authored by Devdutt Thakkar (Associate). 

Background

After receiving thumping majority in the recently concluded general elections, the re-elected NDA government amongst other things focused on boosting infrastructure spending, incentivising affordable housing, relaxing scrutiny for start-ups, promoting less cash economy, etc. However, few announcements by Hon'ble Finance Minister [such as investment linked benefits under section 35AD of the Income Tax Act, 1961 ('Act'), etc] were absent in the Finance (No 2) Bill, 2019 ('Finance Bill'). From a non-resident perspective, on one hand, the Finance Bill proposes to provide tax incentives to promote International Financial Services Centre as well as relax conditions in case of Offshore funds. Whereas, on the other hand, the Finance Bill proposes to widen the tax base by levying tax on non-resident receiving any sum of money or specified property[1] for inadequate or no consideration. Further, the Finance Bill also proposes to bring parity with respect to disallowance of payments (on which either tax has not been withheld or tax so withheld has not been paid) made to non-resident payee at par with payments to resident payee. In the ensuing paragraphs we have elucidated these proposals, relaxing the norms of disallowance of payments made to non-resident payees and the conundrum surrounding its applicability.  

Proposals in relation to provision of section 201 and 40(a)(i) of the Act

With effect from April 1, 2013, the provisions of section 201 of the Act provides that where taxpayer fails to withhold taxes or fails to deposit taxes so withheld on payments to resident payee, such taxpayer shall not be considered to be an 'assessee in default', if such resident payee:

• furnishes its income-tax return;

• accounts into such payments for computing income in its income-tax return;

• pays tax due on such income declared; and

• furnishes Chartered Accountant's certificate in relation to above.

However, the above provisions were not applicable in case of payments to non-resident payee. Therefore, in order to remove this anomaly, the Finance Bill proposes to extend the above relaxation even to cases where payments are made to non-resident payees. Consequently, in the above case, the Finance Bill also proposes to restrict the levy of interest till the date of filing of income-tax return by such non-resident payee.

Similarly, it also proposed to not disallow such payments in the hands of taxpayer, by amending the provisions of section 40(a)(i) of the Act, subject to the non-resident payee furnishing the aforesaid prescribed information. These amendments shall be effective from September 1, 2019.

In relation to the aforesaid proposals by the Finance Bill, a question that arises is whether these proposals ought to be effective on prospective basis or should they apply retrospectively?

In order to analyse the application of these proposals, a brief summary of key legislative amendments that have been undertaken in section 40(a)(i) and 40(a)(ia) of the Act have been tabulated as under:

Some of the arguments supporting a view that the aforesaid proposals ought to be applied retrospectively are as under:

• Retrospective application in case of payments to resident payee - In the past, there have been several rulings wherein courts have adopted a view that in case of non-withholding of taxes on payments made to resident payees, the proviso to section 40(a)(ia) of the Act (refer Sr no. 6 of the table above) should apply retrospectively with effect from April 1, 2005. However, this view has been challenged by the Indian income tax authorities and the matter is currently pending for adjudication before the Apex court of India.

• Non-discrimination clause in Tax Treaties - It is imperative to note that there exists a non-discrimination clause in many of the double tax avoidance agreements ('Tax Treaties') entered into by India. One of the objects this clause is to ensure parity in the condition of deductibility of the payment in the hands of the taxpayer where the payee is either a resident payee or a non-resident payee. In view of the said non-discrimination clause, for the period prior to AY 2005-06, some of the courts in India have adopted a view that no disallowance is warranted [in accordance with the provisions of section 40(a)(i) of the Act] in respect of payments made to non-residents (on which either the tax has not been withheld or the tax so withheld has not been paid).

Thereafter, for the period after AY 2005-06, even before the aforesaid proposals, the Hon'ble Income Tax Appellate Tribunal, Delhi bench[2] has held that relaxation under the proviso to section 40(a)(ia) of the Act (refer Sr no. 6 of the table above) was to be read into section 40(a)(i) as well and was required to be treated as retrospective in effect in the same manner as proviso to section 40(a)(ia) had been treated. Thus, based on the said ruling, it can be argued that so long as the non-resident payee is able to furnish aforesaid prescribed information, no disallowance ought to be made. However, in case non-resident payee is not able to furnish prescribed information then, in view of non-discrimination clause of applicable tax treaties, for the period on or after AY 2015-16, one can contend that disallowance ought to be restricted to 30% of the payments.

• Curative amendment removing anomaly - There are several rulings of the Apex court of India which have held that amendment which is curative in nature or solving any anomaly in the existing provisions should be read into the section since their inception.

However, the aforesaid view may not be endorsed by the Indian income tax authorities and subject to further litigation. Hence, with an intent to reduce litigation, the Indian Government may issue necessary guidance in respect of application of the aforesaid proposals.

The views expressed in this article are personal views of the authors and should not be construed as professional advice.

[1]As per the provisions of section 56(2)(x) of the Act  

[2] In the case of Mitsubishi Corporation India (P.) Ltd [2015] 44 ITR(T) 416 (Delhi - Trib.)

Budget 2019 - A Step towards Refining Secondary Adjustment Provisions

When India introduced secondary adjustment in its transfer pricing regulations vide the Finance Act, 2017, it had adopted the scheme of imputing interest on the amount of primary adjustment inflicted upon the taxpayer, which was rechristened as a deemed loan extended to the overseas associated enterprise (AE), being the counterparty to the relevant transaction.

The incidence of tax on interest got triggered if the amount of primary adjustment was not repatriated by the overseas AE in fvaour of the Indian taxpayer within 90 days of determiniation of the same, either in the form of a suo moto act on the part of the taxpayer in offering an adjustment in the tax return; or through intervention of the Revenue Authorities in the form of assessments, namely having reached finality in appeals; or resolution of mutual agreement procedures or advance pricing agreements.

In case the amount of primary adjustment would never be repatriated in favour of the taxpayer, then the imputation of interest would have run till perpetuity. The rate of interest was fixed at six month LIBOR plus three hundred basis points, in case the international transaction was denominated in foreign currency, else a rate of one year marginal cost of lending of State Bank of India plus three hundred twenty five basis points was prescribed.

Countries, which have introduced secondary adjustments in their domestic tax legislations, generally adopt the deemed dividend route for collecting tax on the primary adjustment, rather than the imputation of interest on the same by recharacterising the same as a deemed loan. A brief analysis of the mechanism of secondary adjustment adopted by various countries is made below :

• The international guidance on the relevant topic indicates that most countries that have secondary adjustment as part of their legislations, have adopted the concept of deemed dividend. As part of this approach, countries treat the primary adjustment in TP as deemed dividend income, which is then subject to tax either as per the provisions of their domestic tax laws or tax treaties, whichever is more favourable to the taxpayer. Some of the countries that have adopted this approach, are Canada, France, South Africa, United States, Germany, Bulgaria, Spain, Korea, Austria and Denmark.
• A further improvised approach adopted in some countries has been to distinguish the secondary adjustment depending upon the shareholding structure between the resident and the AE, e.g. in case of transfer of economic value from parent to subsidiary, the same would be construed as deemed capital; and in case of  transfer of economic value from subsidiary to parent, the same would constitute deemed dividend.
• There are very few exceptions to the above, such as Netherlands and Israel, who treat secondary adjustment in the form of a deemed loan in certain specific circumstances, while in general the concept of deemed dividend has been adopted.
• It is important to consider the secondary adjustment provisions of South Africa, which has recently moved away from a deemed loan approach and adopted the deemed dividend approach, irrespective of whether or not the overseas AE is a parent company; or subsidiary company; or any other group company of the taxpayer. Some of the key reasons cited by the Revenue Board of South Africa for switching over from a deemed loan to a deemed dividend approach for the purposes of secondary adjustment in TP, include - (i) administrative and compliance burden experienced by tax authorities in tracking interest rates; (ii) capitalisation of unpaid loan balances; (iii) loan until perpetuity with no obligation to pay unless there is a case of liquidation; and (iv) the absence of any legally binding agreements.
• It is interesting to note that in Netherlands and Austria, the law provides that if a taxpayer is able to demonstrate that the country of the AE would not allow credit for the taxes paid by the taxpayer on account of secondary adjustment, on the enhanced income of such AE, then the secondary adjustment may not be sustained.

In the background of the practice followed in the aforesaid countries, the regulations around secondary adjustment initally adopted by India appeared slightly rigid, namely mandatorily prescribing the mechanism of imputing interest by recharacterising the primary adjustment as deemed loan, irrespective of whether the relevant overseas AE was a part of the clan of ancestors or part of the group of descendents of the taxpayer. Further, the imputation of interest till perpetuity, in the event the amount of primary adjustment would have never been repatriated, appeared to be too hasrh on the taxpayer.

The Finance (No 2) Bill, 2019 has made an attempt to address the aforesaid issue through proposing an alternative to taxpayers to pay a “one-time” and final income tax @ 18% (without considering surcharge and cess thereon) on the amount of primary adjustment for being absolved from the rigours of being taxed on notional interest on the same amount till perpetuity or until the said sum was repatriated in favour of the taxpayer by the overseas AE.

It goes without saying, as has been introduced as a precautionary measure in the Finance Bill, the taxpayers would neither be able to claim any credit for such one time tax nor deuction with respect to the amount of principal adjustment. Incidentally, even if not explicitly mentioned in the fineprints, the taxpayers subject to secondary adjustment under the deemed loan route would have also not been able to claim any such credit or deduction.

The Finance (No 2) Bill, 2019 has proposed to introduce the above provisions with effect from 1st September, 2019. Therefore, though an amendment of a substantive provision, it appears that even if the primary adjustment has been determined any time prior to 1st September, 2019, albeit relating to the assessment year 2017-18 or thereafter; and due to non repatriation of the same in favour of the taxpayer within three months from such determination, the taxpayer had been paying income tax on imputed interest on such principal adjustment as per the provisons of secondary adjustment currently in vogue, post 1st September, 2019, the taxpayer would have the option of settling its liability towards tax on the account of secondary adjustment through the payment of such one time and final tax @ 18%.

Thus, going forward, taxpayers facing primary adjustments would need to choose the option of either paying tax @ 30% on interest on notional loan until the amount of principal adjustment is reptariated; or pay the one time and final tax thereon @ 18%. Since the rate of tax in either case would be enanched with the levy of surcharge and cess, no reference is made to such elements for the sake of convenience in this article.

I guess in case a taxpayer would never receive the amount of principal adjustment from the overseas AE due to whatever decision making process of the MNE group, then adopting the option of payment of one time and final tax @ 18% would be more prudent. On the other hand, in case the taxpayer would have plans to receive the amount of principal adjustment from the overseas AE in the foreseeable or near future, if not within three months from determination thereof itself, then adopting the option of interest on deemed loan would certainly be more favoured, since without applying the discounting factor to adjust future cash flows to the present value, equality in the quantum of the two incidence of taxes would be achieved over a period of twelve to fourteen years.

While the attempt of the Government in reducing hardship upon taxpayers in the context of secondary adjustment in transfer pricing is certainly laudible, yet the Government may consider some finer adjustments to the proposed amendments on the following lines :

1. The chances of amounts of primary adjustments never being repatriated to India would be far higher in cases of taxpayers who are subsidiaries of foreign MNE groups, since the control and decision making powers would vest at the headquarter levels situated overseas. Further, any amount of primary adjustment, even if repatriated in favour of the Indian taxpayer, would ideally need to be remitted back as dividends, unless ploughed back for investments in India.

2. Since India is predominantly an inbound economy, majority of the taxpayers, who are subject to transfer pricing in India, are subsidiary compnaies of foreign MNE groups; or in other words, their overseas AEs would belong to the clan of parents and ancestors. Therefore, any principal adjustment inflicted upon such taxpayer in India, namely subsidiary of a foreign MNE group, while dealing with any of its overseas AE, would take the colour of money residing in the coffers of shareholders or their clans, thus assuming the character of a deemed dividend.

3. Therefore, while introducing the concept of one time tax to absolve the liability on account of secondary adjustment, the Government may consider to recharaterise the amount of principal adjustment as deemed dividend under section 2(22) of the I T Act; and subject the same to dividend distribution tax (DDT) @ 15% as per the scheme provided u/s 115-O of the I T Act. 

4. In case the Government shifts to the classical form of taxation of dividends, namely taxing the same in the hands of the shareholder, instead of on the compnay, then the deemed dividend in the form of the unrepatriated amount of principal adjustment, may suffer withholding tax in India as per the rate provided in the tax treaty executed by India with the country of residence of the foreign AE, belonging to the ancestral clan of the taxpayer in India. 

5. So far as taxpayers who are Indian headquartered MNE groups, it is most likely that with the controls of the groups residing in India, the amounts of principal adjustments would be repatriated by their overseas AEs, being belonging to the clan of desdendents, in fvaour of the taxpayers, thus for such compnaies, it would be more prudent to adopt the option of impuation of interest on deemed loans till the time of repatriation of such amounts of principal adjustments. Therefore for taxpayers who are Indian headquartered MNE groups, the option of making a one time payment of tax @ 18% for being absolved of the liability towards secondary adjustment in future years, may not be as lucrative; and thus need not be extended to them. 

If the Government decides to refine the amendments proposed to be introduced with respect to secondary adjustments on the aforesaid lines, the same would be as equitious and judicious, as they can get. Yet, one certianly applauds the attempt of the Government in at least taking the step in the right direction.

Budget 2019 - Resolving Primary Concerns of Secondary Adjustment

The concept of 'secondary adjustment' was introduced by Finance Act 2017 by introducing a new section 92CE in the Indian Income Tax Act (the Act) to align transfer pricing provisions with international best practices.

As a concept, secondary adjustment arises when the taxpayer agrees to a transfer price, which is different from what is recorded in the books of accounts. The taxpayer can agree to this different transfer price, either suo moto at the time of filing tax return, or once the transfer pricing adjustment is done by the tax officer and not further litigated, or during the  APA or MAP proceedings. The provisions require Indian taxpayers to repatriate the difference in transfer price as per tax and as per books of accounts (excess money) from the overseas Associated Enterprises (AE) within 90 days. In case the repatriation is not made within 90 days, it would be deemed to be a loan given by the taxpayer to the AE, and the interest shall be computed till the time the repatriation is made by the AE.

The Finance Bill (No. 2) of 2019 now seeks to address some genuine concerns of the taxpayers on the applicability of these provisions and also introduces an alternative to provide relief to those taxpayers who are unable to make a secondary adjustment (repatriation).

Anomaly in applicability:

There was an anomaly which had crept in while introducing the provisions in 2017. The 2017 amendment provided that the secondary adjustment would not be applicable if the following conditions are fulfilled:

a.       Amount of primary adjustment is less than one crore; and

b.      The primary adjustment is made in respect of the assessment year commencing on or before the 1 April 2016;

Thus, the literal interpretation suggests that if the primary adjustment pertains to an assessment year 2017-18 or thereafter, the secondary adjustment will be required even if the quantum of primary adjustment is less than one crore. Also, if the primary adjustment of more than Rs one Crore for a period prior to FY 15-16 also would be sustainable. However, this was not the intention of the law, which was clear from the speech of Hon'ble Finance Minister who had suggested that the provisions of secondary adjustment are not applicable in cases where primary adjustment is Rs 1 crore or less (giving relief to the small taxpayers) or if pertains to the period earlier than FY 16-17 (no retrospective effect).

The Finance Bill (No. 2) of 2019 now seeks to resolve the above anomaly by making the above two conditions alternate (replacing “and” with “or”) to qualify for relief from secondary adjustment. The change is made as a clarificatory one and is applicable from the date the secondary adjustment was introduced. This is a welcome clarification.

Alternative to secondary adjustment: As noted above, the existing provisions seek to characterize the secondary adjustment as a deemed loan and required repatriation of this deemed loan/excess monies.

However, genuine difficulties were being faced by the taxpayers on this account. What may seem as an appropriate transfer price in a certain jurisdiction may not be acceptable to other jurisdiction and the repatriation may be challenged due to the following reasons:

• Regulatory permission: Would the regulatory body of AE jurisdiction permit such repatriation (like RBI and FEMA regulations in India)? 
• Taxation aspect: Whether the repatriated sum would be tax deductible to AE? 
• Accounting and Auditing: The time lag between the date of transaction and date of adjustment
• Disclosure: Would the shareholders/other stakeholders have any reservation to such repatriation
• Impact on Global TP policy: How would the tax authorities of the other jurisdictions (where AE has a similar arrangement) react to such repatriation?
• Assessee is a foreign company: In the event that the AE is also assessed to tax in India (because of PE), any adverse transfer pricing adjustment in the hands of such foreign company in India might also give rise to secondary adjustment situations. How would the repatriation mechanism work in such cases? 

The secondary adjustment related provisions in certain other jurisdictions, such as USA, Canada, Europe, etc., it is typically characterized as deemed dividend/capital and not as deemed loan.

The Finance Bill (No.2) of 2019 now seeks to provide an alternative to the taxpayer from Secondary adjustment/repatriation in the following manner:

Liberalized Repatriation: An option is provided to the taxpayer wherein the repatriation can be made from any associated enterprise that is not a resident in India, and that need not be limited to the associated enterprise with which it had entered into the      transaction.

No Repatriation but a one time tax: Alternatively, the taxpayer may choose not to make secondary adjustment by a one time tax payment at 18% (plus 12% surcharge and 4% cess making the effective tax of 20.96%) on the amount to be repatriated. The taxpayer will have to pay due interest till the date of payment of such one time tax as per the existing provisions, i.e., till the time one-time tax is paid it would continued to be regarded as deemed loan and the taxpayer will have to pay tax on imputed interest.

The taxpayer will not be able to claim credit or deduction of the taxes referred to above from tax payable under any other provision of the law.

This amendment will take effect from 1 September 2019.

It is interesting to note that the APAs signed before the introduction of Secondary Adjustment in the statute did a similar work where the taxpayer was not ready to repatriate. The grievance of the Indian tax authorities and rationale for the introduction of the secondary adjustment was that while based on primary adjustment the taxpayer was paying applicable corporate taxes since the amounts were not reflected in books of accounts, the Government was losing out on dividend distribution tax. In essence, the government is now applying the dividend distribution tax rate without explicitly calling it as a dividend. The reason for not considering this as a dividend would be to avoid litigation perhaps as it would be difficult to levy DDT in cases where the secondary adjustment pertains to AE which is not a direct shareholder in the absence of parent/shareholder relationship.

Concluding remarks 

The proposed amendments are a welcome move providing alternative options to the taxpayers to comply with secondary adjustment related provisions.

Transfer pricing has been an extremely litigation-fertile area in the Indian tax regime. In fact, issues, such as marketing intangible, corporate guarantee, intra-group services, etc., have still not found a judicial consensus in several years of litigation.

Therefore, the question arises how definite/conclusive a primary adjustment/transfer pricing adjustment would be in the eyes of counterparty or AE. If it is subjective, could you compel the AE to compensate for such primary adjustment which in all probability would be outside of contractual terms?

In view of the above questions, it was inevitable for the Indian regulators to re-characterize the secondary adjustment as 'deemed dividend' in line with an approach followed by other developed jurisdictions.

Secondary Adjustment - Breathing a Sigh of Relief!

This article has been co-authored by Anjul Mota (Associate Director, Global Transfer Pricing Services, B S R & Co LLP).

As a backdrop, the Indian Finance Act, 2017 introduced “Secondary adjustment” ('SA') provisions vide section 92CE in the Income-tax Act, 1961 ('the Act').  SA implies that where as a result of a primary adjustment to the transfer price, there is an increase in the total income or reduction in the loss of the taxpayer, the "excess money" (i.e. the difference between the arm's length price determined in the primary adjustment and the price at which the international transaction has actually been undertaken) which is available with its AE, needs to be repatriated into India within the prescribed time.  In case such sum is not repatriated to India within the prescribed time, shall be deemed to be an advance made by the taxpayer to such AE and interest thereon shall be computed in the hands of the taxpayer in the prescribed manner. 

The prescribed approach of treating the SA as “Deemed loan”, is quite onerous and leads to several complications from an Accounting, Exchange Control and several other regulations perspective.

Historically, before insertion of Section 92CE of the Act, the Revenue Authorities have sought to treat the excess transfer price paid to the AE as an advance and sought to make a SA on account of notional interest that should have been charged on such advance. However, the Tribunal notably in the case of PMP Auto Components Pvt. Ltd. [TS-263-ITAT-2014 (Mum)-TP] has dismissed the same stating that the Indian TP regulations as they stood then did not permit SAs. 

Globally, SA could take the form of constructive dividends, constructive equity contributions or constructive loans.  The deemed dividend / equity contribution approach is followed by France, USA, Canada, South Africa, Korea, Spain, Bulgaria, Luxembourg, Netherlands, Germany, and Austria among other countries, since under the said approach a one-time payment is made which can be settled without a carry forward impact.  

In line with international best practices, the SA provisions needed relaxation.  It's indeed a welcome amendment proposed with effect from 1st September 2019, the taxpayer is granted an option to pay one-time additional tax at the rate of 20.16 percent (18 percent tax increased by surcharge of 12 percent) on the excess money or part thereof which has not been repatriated in India. 

One needs to evaluate the one-time payment option with caution as the same would result into additional tax cost for the tax payer, for which no credit would be available in India. 

The following table illustrates the impact of tax cost as per Budget 2019 proposal:

(Amount in Rs.)

* Assuming taxable income of more than 10 crs and with a surcharge of 12%

** Assuming net amount repatriated out as dividend, DDT liability computed on grossing up basis

For the sake of comparison in the above table, it is assumed that under scenario 1, the SA amount repatriated into India post Income-tax payment is distributed as dividend.  It can be observed from above that one would pay comparatively lower tax in India under scenario 1, wherein funds are remitted into India and then subsequently repatriated by way of dividend rather than scenario 2, wherein one time additional tax payment option is chosen by the tax payer.

Further, it can be examined whether the deduction of Rs. 1,000 remitted into India can be availed in the overseas jurisdiction.  In such a case from the group perspective, an option of remitting funds can be more efficient instead of opting for one-time additional tax payment option. 

Without doubt, an option of paying of one-time additional tax is much beneficial instead of paying a recurring interest by treating SA as deemed loan. 

It appears that only in the situations, wherein due to regulatory restrictions in the overseas jurisdiction or due to other unavoidable circumstances, funds could not be repatriated in India, the tax payers could opt for one time additional tax payment option else they would prefer remittance route to minimize the tax incidence on the group. 

Relaxation has been sought from various quarters with respect to SA provision, as treating SA as deemed loan has caused significant hardship.  By providing one-time additional tax payment option, the compliance burden with respect to SA provision will reduce significantly.

Applicability of exchange control and other extant regulations and tax considerations in overseas jurisdictions, may also be analyzed in order to carry out the aforesaid provisions. 

Other provisions:

Yet another welcome move is to allow repatriation of excess money or a part thereof into India from any of the non-resident Associated Enterprise and not necessarily from the same AE in respect of whom the Primary Adjustment is made. 

Following other amendments have been introduced with respect to the SA provisions, with effect from AY 2018-19 and subsequent years

·         SA provisions to apply only in case of APAs signed on or after 1st April 2017;

·         The existing dual conditions for non-applicability of SA made alternative to each other

(a) primary adjustment does not exceed INR 1 crore; or

(b) primary adjustments made on or before AY 2016-17

The said clarification was much awaited and makes the provisions more easier to implement. 

Suggestions for future:

SA treated as deemed dividend:

In order to further align our Indian TP regulations with the International best practices and to be just and fair to the tax payers, one would expect now a corresponding adjustment should be allowed in the hands of non-resident (who are subjected to tax in India on source based income such as royalty etc) in the instances wherein their India counterpart has paid additional tax due to SA provision. 

SA treated as deemed loan:

Under regulations of few other countries like South Africa, UK, etc, inter-company setting off of accounts is allowed for deemed loans arising out of SA provisions, however, the same is not permitted under Indian regulations, which make the Indian regulations more onerous. Permitting such netting off shall ensure that the outstanding loan balances do not remain till perpetuity and the interest on the same does not keep accumulating endlessly. 

The provision requiring the tax payer and Associated Enterprise located overseas to record accounting entries in their books of accounts could be difficult to implement, considering jurisdictional and other legal and regulatory issues.  Hence, the same should be done away with. 

Budget 2019 - An Attempt to Set TP-record Straight!

This article has been co-authored by Amit Dattani  (Senior Manager, Deloitte Haskins & Sells LLP) and Hussain Udaipurwala  (Deputy Manager, Deloitte Haskins & Sells LLP).

A well-balanced narrative was the hallmark of our hon'ble Finance Minister's budget 2019. Overall, a slew of measures have been announced which are futuristic. From a transfer pricing perspective, following clarifications are welcome steps to aid effective implementation of these provisions:

1. Powers of Assessing Officer in respect of modified return of income filed in pursuance to signing of APA (Section 92CC of the Income-tax Act);
2. Provisions of secondary adjustment and granting option to assessee to make one-time payment (Section 92CE); and
3. Definition of 'accounting year' in relation to Alternate Reporting Entity (in Section 286).

Besides above, there is a proposal to rationalize Section 92D i.e. requiring master file to be filed even when there is no international transaction; and restricting powers of assessing officer ('AO') and commissioner (appeals) to call for master file from the assessee[1].

Our focus is primarily to share thoughts on substitution of Section 92D - covering salient points relating to two aspects, outlined above.

I.   Restriction on the power of AO and commissioner (appeals) to call for master file

• A lot of critical and sensitive information about MNE group is outlined in the master file. Broadly speaking, documents like country-by-country report ('CbCR'), master file and local file provide tax administrations with useful information to undertake comprehensive review of TP risks and raise any red flag. Such information facilitate tax administrations to make determinations about where resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries.
• Currently, Section 92D(3) provide the AO and Commissioner (Appeals) a leeway to require any person who has entered into an international transaction or specified domestic transaction to furnish any information or document (simply put, TP report and even master file) during the course of any proceeding under the Act, within the timelines prescribed. Proposed Section 92D(3) restricts such power of AO or Commissioner (Appeals).  With this, assessees can now breathe a sigh of relief.
• Existing provision could have resulted in dilution of the entire framework of effective tax risk assessment that requires tax authorities to cohesively diagnose documentation/information - i.e. CbCR, master file and local file (TP documentation) - through a coordinated, well-informed, thorough analysis stemming from automated data-analytics - namely, complex algorithms, risk assessment tools, risk typologies, other risk detection techniques, and the like[2].  AO/TPO may not have visibility/ sophisticated data-analytics tools, etc. to venture into such domain.
• In the context of CbCR (automatic exchange of information); the protection and confidentiality has been of paramount importance. India has taken cue (from OECD) - as per CBDT instruction[3], CbCR shall be shared by Director General of Income Tax (Risk Assessment) ['DGRA'] with the TPOs as per standard operating procedure ('SOP') formulated by Centralised Risk Assessment Unit of DGRA - in cases selected for scrutiny based on risk assessment. Such protocols amply clarify that focus is more on qualitative aspects and not hardship to assessee (resulting from sharing such confidential information with TPO). Accordingly, some streamlining was in the offing w.r.t sharing of master file, as well.
• OECD BEPS Action 13 clarifies that aforementioned documents/information are to be used sparingly i.e. for limited purpose of facilitating informed risk based assessment. Accordingly, the proposed Section 92D(3) is a welcome taxpayer friendly measure - need of the hour.
• In the same vein, some mechanism/guidelines/ SOPs that enables the competent authority to benefit from robust analysis undertaken by DGRA and qualitatively apply findings to on-going negotiations for bilateral/multilateral APAs, could be a well-received idea - enormously comforting the tax authorities and addressing any base erosion/double non-taxation, etc.  
• With the streamlining of Section 92D(3), it remains to be seen whether APA authorities [not being AO or commissioner (appeals)] will call for master file from the applicant [being the person referred to in Section 92D(1)(ii)], during an APA process, as experienced in certain cases.

II.   Compliance burden broadened for constituent entity ('CE')

• Earlier, master file related compliance (Section 92D read with rule 10DA) was vested on any CE as an additional requirement i.e. in furtherance to normal TP compliance for persons having international transaction or specified domestic transaction (SDT), during the year.
• Now such linkage is done away by insertion of clause (ii) in Section 92D(1) - therefore, persons are mandatorily required to file master file (a broad purposeful interpretation seems filing of 'Part A of Form No. 3CEAA') even if there is no international transaction. This requirement may be onerous as it would increase master file (Part A) compliance burden (in India) for all Indian CEs of MNE as well as overseas entity(s) of international group - even in cases of only third party transactions/merely having PAN and say, no transactions, during the year.
• Strictly speaking, in the absence of any international transactions [including deemed international transactions under Section 92B(2)], any CE may either transact with third party(s), in India or may not have any transactions, per se. Therefore, on a plain reading, master file compliance without international transaction would lead to a general and across the board compliance - maybe a requirement not intended by policy makers but literal meaning of substituted Section 92D(1)(ii) suggests so.
• Furthermore, as per Rule 10DA(4), resident CEs have option to designate an entity for meeting master file compliance requirement (on behalf of multiple resident CEs of same international group). On a plain reading of the said rule, it seems such designation only covers resident CEs (i.e. not extended to non-resident CEs). This may lead to additional compliance burden in case of non-resident CEs, not having international transaction.
• One can contend that this broad compliance requirement seems a misfit in the narrative of substituted Section 92D; being purely a TP provision, per se.  Overall, this rationalization may be an arrow in the dark. Needless to say, operationalization/monitoring of such additional compliance burden may not go well with MNEs.
• On a flipside, this onerous master file compliance requirement may, in fact, be a well-thought out proposition - on the part of Indian law makers - to enhance the footprint of DGRA to monitor/analyze (through sophisticated data-analytics) an MNEs taxable transactions (including third party transactions) in India, from overall BEPS perspective. 

Conclusion

Restriction on the power of AO and commissioner (appeals) to call for master file is a welcome step aimed at maintaining and appreciating the sanctity of a comprehensive review of TP risks duly advocated by OECD.

In the context of master file compliance for CEs not having any international transactions - it seems that there is some disconnect. A clarification may be on the anvil.

Overall, TP proposals are clearly an attempt to touch the right cords...efficiency, efficacy and effectiveness being the final goal.

[1] Para 7.5 of Annex to Part B of Budget Speech

[2] BEPS Action 13 - Handbook on Effective Tax Risk Assessment (2017)

[3] Central Board of Direct Taxes (“CBDT”) has issued an internal instruction (instruction no. 2/2018) dated 27 June 2018

Budget 2019 - Transfer Pricing Hits & Misses

This article has been co-authored by Asma Afzal (Chartered Accountant).

Transfer pricing(TP) regulations require justification of the arm's length price through comprehensive documentation requirements. TP analysis, being complex in nature, emanates an uncertainty on acceptance of the transfer prices by the tax authorities. At the outset, it is imperative to note that the Indian TP regulations have various provisions to reduce litigation on matters relating to TP, providing a certain level of assurance to the taxpayers including the Advance Pricing Agreement ('APA'), Safe Harbour ('SH') provisions and risk based assessments.

The Budget 2019 announced on 5th July 2019 proposed certain amendments and clarifications in the TP provisions, majorly covering amendments to secondary adjustment provision and minor clarifications regarding APA, documentation requirements under section 92D and Country-by-Country Reporting ('CbCR'). However, the budget gave a miss to the much anticipated renewal and rationalisation of the Safe harbour ('SH') provisions.

-       Safe harbour- not playing safe anymore?

To provide some leeway to the small and medium taxpayers, the SH rules were introduced in 2013, simplifying TP compliance through providing certainty on acceptance of transfer prices for international transactions between Associated Enterprises ('AEs') by the tax authorities.

The SH provisions relieved eligible taxpayers from undertaking extensive TP compliance, allowing a certain level of assurance on how the transfer prices would be perceived by the tax authorities. However, the SH rules introduced in 2013 prescribed overly high markups and failed to achieve popular acceptance among the taxpayers. As a rationalization measure, these rules were revamped in 2017 and made effective upto AY 2019-20, prescribing lower margins and covering additional transactions.

The APA provisions provide a mechanism for avoiding litigation by negotiating a transfer price with the tax authorities for a certain period of time. In comparison of the SH, APAs prove to be costlier and more time consuming, although the ambit of APA is not restricted to few transactions. SH rules prescribed low threshold and high markup, covering a limited number of transactions.

Even in light of its shortfalls, the SH provisions proved instrumental in reducing compliance cost and efforts for certain taxpayers and providing a reasonable certainty that the transfer prices would be accepted by the tax authorities if the conditions were met.

With the release of the Budget 2019, it was expected that the SH Rules would be renewed and rationalized to instill confidence among the taxpayers, specifically the medium enterprises which are not in receipt of incentives and relief, existing as well as proposed, from various compliance burdens as proposed for the startups However, the same was overlooked and no renewal was announced.

One-time payment; an alternative to Secondary adjustment

In order to align the Indian TP regulations with the international best practices, the Secondary adjustment provisions were introduced through Finance Bill 2017, requiring the taxpayer to repatriate the excess money determined on transfer pricing adjustment from the foreign AE within a specified time period, failing which it would be treated as a loan and interest would accrue thereon. Globally, the dividend approach had been popular, being more effective and compliance friendly, requiring a one-time payment without making adjustment in books.

As a respite from difficulty faced in repatriating the money from the foreign AE, the Budget proposes to provide an option to opt out of secondary adjustment by onetime payment of tax, where the taxpayer pays an additional income-tax of eighteen percent on the excess money increased by a surcharge of twelve percent. This, is in line with the secondary adjustment mechanism followed worldwide.

Further, the memorandum also clarified that the conditions for exemption from applicability of secondary adjustment provisions are to be read separately, i.e., either where excess amount does not exceed INR One Crore or primary adjustment is made up to AY 2016-17.  Thus, exemption from the provision as per the blanket limit of one crore is applicable irrespective of the assessment year to which the primary adjustment is applicable. Earlier, both the conditions were read conjointly, therefore also covering primary adjustments after AY 2016-17 where the amount was less than INR One Crore.

-       Applicability of Master File

Section 92D, which requires taxpayers to maintain prescribed documentation regarding their international transactions, was amended to include the requirement for taxpayer, being constituent entities ('CE') of an international group ('Group') to file a Master File in required forms, if the prescribed thresholds were met.

Earlier, Master File requirement stemming as a proviso to the provision requiring local documentation to be maintained where international transactions are undertaken between Group members lead to the interpretation that no form was required to be filed in absence of such international transactions.

Section 92D is now being substituted with effect from AY 2020-21 to bring about the intent of the law, requiring every constituent entity of a Group to file the required form even in absence of international transactions. Therefore, Indian CEs not maintaining a local file, would fall under the purview of Section 92D to file Master File.

Further, as per the proposed amendment, the assessing and appellate authorities are not empowered to call for information in relation to Master File. This is in line with intent of the BEPS Action Plan 13 which clearly specified that MF would not be a substitute for TP assessments and would not be used as a basis for transfer pricing adjustments.

-       Clarification on 'Accounting year' for CbCR

It has been clarified that the 'accounting year' for the purpose of CbCR filed by an Alternate Reporting Entity would be the accounting year followed by the Ultimate Parent Entity of the Group.

-       Rectification of order in pursuance of an APA

It has been clarified that the on conclusion of an APA, where the assessment has already been complement and a modified tax return is filed by the taxpayer, the AO is empowered to pass a modified order to the extent to give effect to the terms of the APA. Therefore, the modification is limited to the transactions covered under the APA and would not allow a fresh assessment or reassessment to be undertaken.

While the Budget did touch upon various open ended issues in the TP arena bringing down the risk of exposure of adjustment and litigation faced by the taxpayers, at the same time it failed to address the difficulty faced by small and medium taxpayers on account of extensive annual compliance requirements. Suffice to say, any amendments on this front, whether the SH provisions or any other measure to provide relief from annual TP compliance to these taxpayers would further promote ease of doing business in India and bring forth a reassuring outlook towards developing a just and fair transfer pricing regime.

Transfer Pricing - Inching Closer to Global Standards?

This article has been co-authored by Adarsh Rathi (Director, Transfer Pricing, Nangia & Co. LLP).

The Finance Bill 2019 (FB) under Modi Government 2.0 was presented under the overhanging challenges of slower economic growth, declining tax collections, ways to attract more investments into the country, giving a boost to industries, etc. to fuel the growth. Batting on a sticky wicket, the Finance Minister (FM), in her maiden budget, has craftily articulated various measures in the FB to revive the confidence of manufacturing sectors, financial institutions and investors, focus on Start-up India, MSME & Digital India, Electric Vehicles, etc.

Amidst all the proposed amendments in the FB, there have been some welcome clarifications/amendment on the Transfer Pricing (TP) regulations. This budget is another example of the keenness of this Modi Government on not to lose momentum and staying close of the realities on the ground.     

· Rationalisation of Secondary Adjustment provisions - When the Finance Act 2017 introduced the secondary adjustment provisions, there was ambiguity on the condition of non-applicability of such provision (i.e. primary adjustment of INR 1 crore and upto Assessment Year (AY) 2016-17) that could have led to unintended applicability of secondary adjustment provisions to certain taxpayers.  The FB clarifies this uncertain position by proposing that the exemption threshold under Section 92CE of the Income Tax Act, 1961 (the Act) is an alternate condition and not a cumulative one. Further, it has been clarified that the provisions of the amended Section shall apply in case of APAs agreed on or after 1st April 2017 only.  Also, no refund of the taxes paid under the pre-amendment regime shall be made (which is justifiable).

The FB also proposes a welcome move in the secondary adjustment provisions by allowing the excess money under secondary adjustment to be repatriated from any of the associated enterprise (AE) of the Taxpayer vis-à-vis AEs with whom transactions were undertaken. Thus, the Taxpayer's existing concerns where transactions were undertaken with multiple AEs and a situation of each AE repatriating funds which was leading to practical challenges, has been taken care of. 

Another highlight of the secondary adjustment proposed revision has been an 'One-time payment option' wherein, the AE need not repatriate the additional funds into India.  However, the cost of exercising such non-repatriation option will be additional income-tax at 18% with a surcharge of 12% (bringing the effective tax rate on such secondary adjustment to 20.16%), in addition to the existing requirement of calculation of interest till the date of payment of this additional tax.  Further, such payment will not be allowed as a deduction in any of the other Sections of the Act.. 

The amendments in the Secondary adjustments will provide an option to the Multi National Enterprises (MNEs) from cash flow management or cash repatriation perspective which otherwise would have been triggered.  These provisions will be effective from 1st September 2019.

· Review of Modified Return under APA - APA being a mechanism covering 5 forward years and 4 roll back years has rules regarding furnishing of modified return post signing of the APA. A modified return is filed for year(s) where the original return was filed prior to signing of APA but due to the final agreement of APA, there arises a need to revise the total income being offered to tax post APA sign off.  Considering the existing verbiage of the provisions of Section 92CD of the Act wherein words like 'assess or reassess or recompute' existed, it could lead to a situation of restarting of fresh proceedings previously closed by Tax officers. 

Accordingly, the FB proposes to clarify that the powers of the Tax Authorities would be restricted only to the modified portion of the total income pursuant to and in accordance with the APA.  This is certainly a welcome clarification which otherwise was and could have resulted in additional litigation process, contrary to the basic intent of the APA program.

· Clarification on “Accounting Year” for Country-by-Country Report (CbCR) - Prior to the FB, there was a dilemma on which accounting year needs to be considered where there was an Alternate Reporting Entity (ARE) resident in India. It was always a debate whether Indian financial year or ultimate parent accounting year were to be considered for ARE in India. This issue became more prevalent when the subsidiaries of US Parents were required to file CbCR in Form 3CEAD, earlier in the year.     However, the same is clarified in the FB with the proposed amendment in Section 286 of the Act, to delete ARE thereby leading to a clear stand of considering accounting year of the Parent entity even if the ARE is resident in India.  This would also imply that even if the ARE is outside India, in such cases accounting year of the Ultimate Parent Entity is to be considered.  The amendment being clarificatory in nature, will take effect retrospectively from the 1st April, 2017 and will, accordingly, apply in relation to the Assessment Year 2017-18 and subsequent assessment years.

· Reporting compliance for constituent entity in India - The FB while proposing a revision in the entire Section 92D of the Act (documentation in relation to international transaction) attempts to include certain compliance reporting for companies which even though part of the MNC group but not having any international transaction during the year.  As per the FB, it is proposed that even if a particular company does not have any international transaction during the year, it will still need to provide and document formation under Rule 10DA of the Income Tax Rules, 1962 (known as Part A compliance under Form 3CEAA). This again is a clarificatory change since the existing regulations had elements of adopting a contrary position.

· Removal of “arm's length compliance” requirement in case of offshore funds - Section 9A of the Act provides for conditions in the implementation of regime of fund managers. These conditions, inter-alia, are related to payment of remuneration of fund manager at arm's length. Accordingly, to give a thrust to fund management activities in India, it has been proposed to relax certain constraints with one of them being the arm's length condition of fund manager's remuneration to be replaced by an amount not less than the amount calculated in the manner that may be prescribed.

Conclusion

Modi Government 2.0 has amidst a sensitive business environment continued to press the pedal to push the economy towards greater certainty and non-adversarial investor-friendly regime as started in Modi Government 1.0 era aligned to its long-term vision of India.

As Indian TP provisions have evolved overtime, though there still exist various aspirational and improvement areas like alternate dispute resolution mechanism process, clarity on complex transactions, efficiency in TP assessment processes, etc. which could have been addressed in the first FB of Modi Government 2.0 regime.  Having said this, all the proposed amendments in the FB have been welcome breather for Taxpayers and are well thought of suggestions. With the cricket fever on, we hope that the Modi Government 2.0 keeps up the same run rate in the future Budgets as well.

Highlights of 35th GST Council Meeting

The article has been co-authored by Mr. Kartik Bahl (Manager).

Introduction 

The Goods & Services Tax (GST) Council met for the first time after the swearing in of the new Government on 21^st June 2019. 

During the 35^th meeting, the Council deliberated on various issues such as introduction of new GST compliance framework, electronic invoicing system, tenure of National Anti-Profiteering Authority, reduction in GST rates for electrical vehicles & solar power generating systems, extension of due dates for annual compliance etc. 

Summary of some of the key decisions, rationale behind the decisions and its likely impact is discussed in the ensuing paragraphs. 

Extension of due dates for annual compliance 

Under GST, the annual compliance, consisting of filing of GSTR-9 (i.e. the annual return) and GSTR-9C (the reconciliation statement to be duly authorized by a Chartered Account), is due by 31 December following the end of financial year.  

For financial year 2017-18, the said deadline was last extended to 30 June 2019. However on account of difficulties being faced by taxpayers in furnishing the annual returns/ reports, GST Council has recommended to extend the due date by further 2 months. Accordingly, the filing date for annual return and the reconciliation statement for financial year 2017-18 shall be 31 August 2019. 

The said decision brought much awaited relief to the industry. Lack of clarifications on primary source of data for annual return, methodology for payment of unpaid tax, reconciliation of input tax credit with GSTR-2A balance appearing in returns, methodology for preparing HSN summary etc. added to the complexities for taxpayers to comply with the annual compliance. Delayed release of offline utility of annual return and audit report and ICAI technical guide also added to the tension. 

Thus, it is expected that with further extension, industry should now have enough time to seek clarifications, and decide on the next course of action to complete the annual compliances, which are due for the first time. 

Much recently, the Government has issued a Notification, clarifying that supplier of online information and data base access or retrieval (OIDAR) services from a place outside India shall not be required to furnish annual return and reconciliation statement. The service providers had represented that the activity of reconciling GST revenue with the financials would have been a futile activity as separate financial statements are not maintained for Indian revenue segment. The said decision provides respite to overseas OIDAR service providers who had advocated for the said relaxation. 

Introduction of new GST compliance framework 

Last year, GST Council in its 27^th meeting, approved the principles for filing of new return design, based on recommendations of the Group of Ministers on IT simplification. In order to give sufficient time to taxpayers to adapt, it was decided by the GST Council in this meeting that new GST return process shall be introduced in a phased manner. 

Under the new return process, which is based on the principle of Upload-Lock-Pay, the large taxpayers, having turnover of more than INR 5 crores during the previous financial year, are required to file monthly return in contrast to the quarterly return filing for small tax payers. Under the new system, the taxpayer shall have the facility to continuously upload the invoices on the portal. Further, the buyer would also be able to continuously see the uploaded invoices during the month. 

Under the proposed return framework, tax payers would be required to file a single return, i.e. GST RET-1, consisting of 2 annexures, ANX-1 and ANX-2. Vide ANX-1 (which is similar to GSTR-1), a taxpayer shall be required to upload details of outward supply till 18^th of the subsequent month. Basis the uploading of outward supplies by supplier, the inward details would get auto-populated in ANX-2 on a real time basis. Taxpayer would be required to take an action (Accept, Reject or Pending) on the transactions from 10^th of the next month onwards. GST RET-1 is a summary return (similar to GSTR-3B), in which information with respect to outward supply and inward supply would be auto-populated on the basis of ANX-1 and ANX-2 respectively. 

In view of the above framework, the GST Council in its 35^th meeting, unveiled a six month long roadmap for smooth transition to new GST return framework. A tabular representation of the said roadmap is as follows: 

It is a welcome step that the Council has decided to introduce the new return process in a staggered manner, providing much needed flexibility and adaptability to the industry. However, it is yet to be seen if the new return framework would turn out to be a simplified version of the existing compliance framework or a re-modeled version of matching concept, which was put to abeyance on account of capability and feasibility issues. 

While the proposed model to continuously upload and reject invoices seems ideal, it is pertinent to note that such a model necessities taxpayers to carry out reconciliation of invoices on a large scale. During the past year, annual reconciliation of GSTR-2A with the purchase register was one of the key cause of taxpayers' woes. The fact that the proposed model requires taxpayer to carry out such invoice level reconciliations on a monthly basis may pose a challenge and cause anxiety. 

Further, carrying out such reconciliations and undertaking regular follow-ups with vendors and customers, has till now resulted in use of excessive manpower. Though limited manual intervention was one of the objectives of GST, carrying out reconciliations and follow ups compels multinationals to deploy large tax task force even under GST. The apprehension is that following up with vendors for invoice wise reconciliations under GST should not result in the same effort and chaos as chasing vendors and customers for statutory Forms (such as Form C and Form F) under the erstwhile Central Sales Tax regime. If that be the case, the dealers would not be better off. 

Also, the technical capability of GSTN portal to handle such voluminous data may pose a challenge in implementation of new return framework. 

Rationalization of GST rates                                                                                                                      

The GST Council recommended GST rate changes on supply of few goods.

With respect to electrical vehicles, charger and hiring of electrical vehicle, the Council recommended that the GST rate concession should be examined in detail by the Fitment Committee and brought before the GST Council in the next meeting. It is expected that GST rate on electrical vehicles and charger would be reduced to 5% and 18% from the existing 12% and 28% respectively. 

Further with respect to solar power generating system and wind turbine, it has been directed that the issue related to valuation of goods and services in a solar power generating system and wind turbine be placed before next Fitment Committee. The recommendations of the Fitment Committee would be placed before the next GST Council meeting. 

As regards GST rate on lottery, Group of Ministers (GoM) on Lottery submitted report before the Council. After deliberations, the Council recommended that certain issues relating to taxation (rates and destination principle) would require legal opinion of Learned Attorney General. 

Extension of Anti-profiteering provisions 

Anti-profiteering provisions have clearly been the most controversial provisions under GST. The National Anti-profiteering Authority (NAA) was established under GST Act, to monitor and to oversee whether the reduction or benefit of input tax credit is reaching the recipient by way of appropriate reduction in prices or not. Earlier, the Anti-profiteering provisions were to apply till 2 years from introduction of GST (i.e. till 30 June 2019). 

The Council has now extended the tenure of NAA to a further 2 year period. The extension of term of NAA by 2 years clarifies the intention of Government to sustain anti-evasion measures under GST. 

Post the Council meeting, the Government has also made significant changes in Anti-profiteering provisions. One of the key changes is insertion of Rule 133(5) (a), which provides power to NAA to direct Directorate General of Anti Profiteering (DGAP) to investigate into goods or services other than those covered in the report submitted by DGAP. Further the investigation of other products shall be deemed to be a fresh proceeding. It is further provided that in order to initiate proceeding for other products, NAA must have reasons which are to be recorded in writing. The said change surely increases the ambit of Anti-profiteering proceedings. 

Additionally, the Government has doubled the time limit to 6 months for DGAP to complete the investigations from date of receipt of the reference from the Standing Committee. Subsequently, NAA can now issue the Order within 6 months, as opposed to 3 months earlier, from the date of receipt of report from DGAP. Further, standing committee can now apply for a 1 month extension from the NAA, in addition to the 2 months allowed for examining a complaint or application. 

Also, the Council has sought to impose a 10% penalty on a taxpayer if the quantified profiteered amount is not deposited within 30 days. 

The Government has further empowered NAA to summon any person in relation to an Anti-profiteering inquiry. This was earlier limited to the DGAP or its officers only. 

In view of the foregoing changes, it is clear that the Government of India has further empowered the anti-profiteering authorities to regulate the profiteering in the industry. 

The extension of tenure and further empowerment of Anti-profiteering authority may further increase issues for the industry, given that there are no clear guidelines for computing and determining the profiteering. One would hope that the Council would address this industry-wide pressing need for clarity on methodology for anti-profiteering, to reduce interpretational disputes in future. 

E-invoicing 

The Council has also decided to introduce electronic invoicing system in a phased manner for Business to Business (B2B) transactions. E-invoicing is a rapidly expanding phenomenon which would help taxpayers in backward integration and automation of tax relevant processes. 

It would also help tax authorities in combating the menace of tax evasion. The prime objective of introducing such a concept is to bridge the gaps and mismatches between various returns and to curb fraudulent invoicing. Phase 1 is proposed to be voluntary and it shall be rolled out from January 2020. 

Under E-invoicing concept, it is believed that the Government intends to introduce 'Invoice Reference Number' (IRN), which would be reflected on each invoice issued by supplier in case of B2B transactions. Further, it is likely that E-invoice would be required to be issued by taxpayers, whose turnover is more than INR 50 crores (tentatively). The invoice data so uploaded through E-invoicing would be used by the GST system for drafting outward returns and for generation of E-waybills. 

The proposal to introduce E-invoicing, alongside new compliance framework, would bring about a radical shift, leading to global conformity in respect of compliance, with India following the leads of European and Latin American countries. 

However, it would be interesting to witness if the GST infrastructure can intake such huge amount of data. Further, the integration of tax payers' ERP systems and E-invoicing portal would also be an important area of discussion in this regard. 

After the conclusion of the meeting, the Government has introduced an amendment in GST rules relating to issuing tax invoices and bill of supply. Vide this amendment, the Government has specified that it may, by a notification in future on the recommendations of the Council, specify that the tax invoice or bill of supply shall have Quick response (QR) code.

Legacy Dispute Resolution Scheme - An honest reflection of maximum governance minimum government

The article has been co-authored by Sneha Ghosh (Associate).

In the Budget speech, the Hon'ble Finance Minister announced a dispute resolution scheme for pending litigations of the erstwhile Indirect tax regime. It aimed to unlock Rs 3.75 lakh crore involved in cases relating to service tax and excise duty. At the first brush, the scheme brought back memories of the government's dismal attempts earlier vide Voluntary Compliance Encouragement Scheme in 2013 and Indirect Tax Dispute Resolution Scheme in 2016. 

Honestly, we were on the verge to dismiss this scheme as mere travesty. However, a detailed reading of the Sabka Vishwas (Legacy Dispute Resolution Scheme), 2019 ('Legacy Scheme') revealed a pragmatic step with a clear intent to alleviate both the taxpayer and the revenue from the ghost of past litigations. 

In this article, we will highlight the salient features of the Legacy Scheme.

The Legacy Scheme is a pro-taxpayer device which allows a taxpayer ('declarant') to not only preclude an upcoming litigation but also conclude an identified tax demand. The Legacy Scheme covers the erstwhile Central Indirect Tax laws (including Central Excise Act, 1944; Finance Act, 1994; various Cess legislations etc.). 

The declarant gets an option for settlement of the tax dues right from the stages of arrears of taxes, self-detection, enquiry and audit by the revenue till the matters pending before the Adjudicating Authorities, Appellate Forums as well as Courts till Supreme Court. The ongoing litigations must be pending as on June 30, 2019 i.e. the final hearing in such matters is yet to take place. To that extent, the scope of the Legacy Scheme is widespread to cover any sort of litigations either actual or probable. 

As a first step, the declarant is required to declare its tax dues and discharge a stipulated percentage thereof. On doing so, the declarant is absolved of balance tax demand as well as full demand of interest as well as penalty. The table below, captures the relief available in the each of the circumstances: 

A declarant is therefore required to deposit the tax dues less the tax relief. In essence, a declarant is only required to pay 30% to 60% of tax amount to bring an end to the litigation. 

On the subsequent acceptance of the declaration and payment of the amount, the relevant authority will issue a discharge certificate. A declarant shall henceforth, be discharged from depositing any further duty, interest or penalty with respect to such an issue and the specific time period. Also, such an issue and time period for which discharge is granted, shall not be subsequently reopened in any other proceeding under the Indirect Tax enactment. 

Interestingly, the Legacy Scheme debars certain issues / taxpayers from its purview. Specifically, refund and situations wherein tax amounts have not been quantified on or before June 30, 2019 in pursuance to an enquiry or audit, have been kept outside the purview. 

Importantly, the Legacy Scheme does not provide any refund where a declarant deposits an amount in excess of tax dues. Further, the deposit needs to be made in cash as against payment through input tax credit and the tax so paid is not creditable as well. 

All in all, the Legacy Scheme is undoubtedly a brave and earnest effort to relieve the taxpayers from unwarranted tax litigations spanning into years. This is an optimum way in which a good Budget is expected to address perennial problems. 

As most of the pending litigations are frivolous and ultimately decided in the favour of taxpayer, this is an attempt of the government to get rid of these disputes. For the taxpayers, it is an opportunity to wipe the slate clean and get-over the legacy issues particularly where the tax demands are meagre or where the legal battle looks tough or long drawn. 

We need to wait to see the implementation of the Legacy Scheme - it can prove to be a legend if implemented and administered with a right spirit. 

Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019 - A bird's eye view

The article has been co-authored by Mr. Sanjeev Nair (Senior Associate)

Tax amnesty schemes have always been a matter of debate on the ground of equity and fairness inasmuch as they appear to punish an honest or obedient tax payer by seeking to cover up administrative inefficiencies or court inadequacies. Whether amnesty should be introduced or not could be debated for ever, the government often falls prey to the temptation to get quick redressal of disputes and garner some revenue.

Be that as it may, we have one more amnesty scheme, introduced by the Hon'ble Finance Minister in the Union Budget presented on the 5th of July 2019, titled “Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019” ('Scheme'). The Scheme will offer an opportunity to seek closure of inter alia Central Excise and Service tax litigation. Since Customs is outside the GST regime, disputes under Customs law cannot be settled under the Scheme. Similarly, certain excisable goods not moving into the GST are outside the Scheme.

The Government seems to be eying for a pie out of estimated Rs. 3.75 Lakh Crore Revenue currently blocked in pending litigation. With 2 years into the new tax regime of GST, the Government does not want to burden the administration and the courts in dealing with this past burden. If we leave aside the job of fixing responsibility for creating this undue pendency, the thought of getting rid of legacy disputes is certainly welcome. The industry and administration will be able to focus on managing the new tax era more efficiently than to spend time in dealing with the past litigation.

The table below gives a bird's eye view of the relief offered by the Scheme:

Lower success rate of the government in litigation, probably justifies handsome relief offered to induce assesses to come forward and opt for the Scheme. Readers are advised to go through the Scheme document for more details.

Once the declarant pays the amount payable under column (4) above, he will be free from balance tax dues, interest, penalty and prosecution with respect to the settled dispute. What the Scheme makes more interesting is if the assessee has made any deposits during pendency of litigation, the same can be adjusted against the dues payable under the Scheme. There will be no refund however, even if such deposits happen to be higher than the dues payable under the Scheme. Further, the tax dues are required to be settled in cash and cenvat credit balance (or the ITC under GST) cannot be used to make payment of dues under the Scheme. Also, any dues paid under the Scheme will not be available as Cenvat credit/ITC of GST to the declarant.

While it is appreciated that in amnesty scheme it will be difficult to balance equity and fairness in toto, what is glaring in the present Scheme is the person making voluntary disclosure of his tax dues is at a significant disadvantage as compared to the person making disclosure after being issued notice or being investigated. Similarly, under the exception category, it would have been fair to cover a person who has collected the tax but not paid to the treasury. Otherwise, such persons will unduly enrich themselves with the tax collected and pocketed to the extent of relief granted under the Scheme.

More clarity is required on whether the person who has multiple issues in a show cause notice or order can opt for only one or some of the disputes issues and chose to contest the remaining.

Similarly, some clarification will be helpful with respect to cases where show cause notices or appeals have been heard as of 30 June 2019 and orders are reserved which will probably be passed after 30 June 2019 or matters will be relisted for hearing. This is because clause 124 (a) and (c ) states that where hearing is concluded prior to 30 June 2019, such persons will be ineligible to opt for the Scheme.

Another apparent disconnect is in Clause 124 which disqualifies a person who has filed a return indicating an amount of duty payable but not paid it. However, Clause 123(1)(c)(iii) grants relief to such category of persons. This disconnect needs to be clarified to avoid confusion.

With regard to co-noticees who have been involved in litigation only for penal action against them, whether they can seek relief under the Scheme unless the tax dues are settled by the main notice is something needs to be addressed.

The Scheme suggests that issuance of discharge certificate will not preclude the issuance of SCN for the same matter for a subsequent period. This provision is silent about the previous period. Further, the Scheme envisages that the Revenue officer cannot be said to have acquiesced in the decision on the disputed issue. However, the Scheme is silent on whether the assessee can be said to have acquiesced in the decision on the disputed issue. To encourage more assessees to come forward and opt for the Scheme, it will be important to grant similar immunity to the assessee also.

Last but not the least, in the Scheme there is no clarity on whether designated committee can reject the application on any ground or the options available with the declarant if he does not agree to the amount payable determined by the designated committee.

While GST is still at its nascent stage, already a pile of litigation has started mounting up by way of advance ruling applications and appeals and Writs filed across the Country.  The formal establishment and functioning of the GST Tribunals is only going to open the floodgates for litigation under GST. In this backdrop, the present move of the government to clear legacy litigation is indeed a welcome step.

As they say, the devil is in the details. Let us hope that the amendment to the Bill, if found necessary  or the rules to be notified in due course with clarifications will probably address many of the concerns voiced above.