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March 4, 2015
Indian Budget Focuses on Business-Friendly Tax Tactics
by Stephanie Soong Johnston

Full Text Published by Tax Analysts®

This article first appeared in the March 4, 2015 edition of Worldwide Tax Daily.

Indian Finance Minister Arun Jaitley on February 28 unveiled the government's highly anticipated 2015-2016 union budget, which includes a gradual cut in the corporate tax rate, the deferral of a general antiavoidance rule, and other measures to create a more business-friendly tax environment.

In his budget speech to Parliament, Jaitley noted that the government, under the leadership of Prime Minister Narendra Modi, had inherited an economy of "doom and gloom" after its landslide election win in May 2014. "The investor community had almost written us off," he said.

However, in the past nine months, the Modi government has helped turn the economy around dramatically, resulting in projected 2015 GDP growth of 7.4 percent, making India the fastest-growing major economy in the world, Jaitley said. As part of its work to turn the economy around, the government has been trying to create "a stable taxation policy and non-adversarial tax administration" while also cracking down on India's serious tax evasion problem.

To that end, Jaitley proposed reducing India's 30 percent corporate tax rate to 25 percent over four years, starting in 2016, to stimulate more investment, growth, and jobs. "This process of reduction has to be necessarily accompanied by rationalization and removal of various kinds of tax exemptions and incentives for corporate taxpayers, which incidentally account for a large number of tax disputes," he said.

He also proposed deferring the GAAR's effective date so it applies to transactions taking place on or after April 1, 2017. The GAAR, which was first proposed in March 2012 under Finance Act 2012, would give tax authorities greater powers to examine cross-border transactions for signs of tax evasion. It would also allow authorities to deny tax benefits in cases involving transactions or arrangements that lack commercial substance and exist only to obtain tax benefits.

A memorandum outlining the direct tax provisions in Finance Bill 2015 explains that the delay was proposed partly because of the OECD's ongoing base erosion and profit-shifting project. Because the BEPS work is continuing and India is actively participating in the process, "it would, therefore, be proper that GAAR provisions are implemented as part of a comprehensive regime to deal with BEPS and aggressive tax avoidance," according to the memorandum.

Another major budget proposal is to revise a controversial tax amendment to section 9 of India's Income Tax Act, 1961. The amendment, introduced under Finance Act 2012, allows the government to retroactively levy capital gains taxes on indirect transfers of Indian assets between foreign companies dating to April 1, 1962. The surprise amendment was largely seen as an attempt to invalidate a January 2012 Supreme Court decision that threw out a $2.2 billion CGT bill assessed on U.K. telecom giant Vodafone.

Shortly after the amendment was announced, the government created an expert committee to review the indirect transfer provisions and the GAAR introduced in Finance Act 2012.

In the 2015-2016 budget, the government proposes taking into account several of the committee's recommendations. These include changes to ITA section 9 to limit the scope of the retroactive amendment to transactions that exceed INR 100 million (about $1.6 million) and involve underlying tangible or intangible Indian assets that account for at least 50 percent of the value of all assets owned by a foreign company or entity. Other proposed changes include defining the specified date of valuation as the date on which a company's or entity's accounting period ends before the date of the transfer and clarifying that the retroactive amendment will not affect sellers that don't control the overseas target and that hold a stake of less than 5 percent in the company. The changes to section 9 would take effect April 1, 2016.

Jaitley also proposed changing the definition of corporate residency for tax purposes. Currently, section 6, clause 3, of the ITA says that a company is considered tax resident in India if it is an Indian company or is wholly controlled and managed in India. The budget proposes adopting the "place of effective management" test so that a company is considered tax resident if its place of effective management is in India.

Of Elephants and Super Tankers

Other major direct tax proposals include:
  • cutting the tax rate for royalties and fees for technical services for nonresident taxpayers from the current 25 percent to 10 percent;
  • abolishing the minimum alternate tax for foreign institutional investors;
  • amending the ITA to specify that the presence of fund managers in India does not constitute a permanent establishment in India;
  • replacing the wealth tax with a 2 percent surcharge on the super rich; and
  • increasing the threshold limit for specified domestic transactions for the application of transfer pricing rules from INR 50 million to INR 200 million.

Indirect tax proposals include increasing the service tax rate to 14 percent (from 12.35 percent) and a proposed implementation date of April 1, 2016, for India's long-awaited goods and services tax regime. The government in December 2014 submitted a bill to the Lok Sabha, the lower house of Parliament, proposing constitutional amendments that would allow for the GST regime. The proposed two-tiered GST would be destination-based and levied simultaneously by the federal and state governments. (Prior coverage .)

Jaitley also proposed a new law to tackle India's tax evasion problem, including harsher penalties for nondisclosure of taxable income and assets. Key features of the law include imprisonment of up to 10 years for those who conceal foreign income and assets and possible prosecution and jail terms of up to seven years for those who fail to file tax returns or who file returns that inadequately disclose foreign assets.

Jaitley acknowledged that budget expectations were high, with stakeholders who were pushing for "big-bang reforms" comparing the Indian economy to a supertanker or an elephant. "An elephant . . . moves slowly but surely," he said. "I think I have clearly outlined not only what we are going to do immediately but also a roadmap for the future."

Praise and Caution

Tax Analysts contacted several Indian tax practitioners, who generally cheered the business-friendly tax measures contained in the budget.

"The overall thrust of the finance minister in presenting the India budget -- the first full-year financial plan presented by the new government amidst very high expectations of significant reforms -- has been to deliver on the promise of a stable and a non-adversarial tax regime," said Himanshu Mandavia, a partner in KPMG's India Tax Practice on secondment to KPMG LLP in the United States, where he heads KPMG's India Center of Excellence for Tax.

Amit Maheshwari of Ashok Maheshwary & Associates agreed, calling the budget "path-breaking" and "reform-oriented" and saying it emphasizes stability and certainty in tax policy. The proposals to defer GAAR to align it with the BEPS project, along with further clarifications to the retroactive indirect transfer provision, are "going to go down well with industry and prospective investors," Maheshwari said.

Also, the clarification that fund managers do not have a PE in India will bring greater clarity to offshore funds that can "house their management team in India without any adverse tax exposure," Maheshwari added.

Sunil Jain of J. Sagar Associates said that this budget reverses and corrects policies of the past and that he welcomed the deferral of the GAAR and clarifications to the retroactive indirect transfer provision in particular.

He acknowledged the commitment and preparation related to the introduction of the GST regime but said stakeholders "need to watch the developments in next three to four months to see if GST becomes a reality from April 1, 2016."

Aliff Fazelbhoy of ALMT Legal, Advocates & Solicitors welcomed the majority of the budget tax proposals as well but noted that he was slightly surprised by the service tax increase and the "extremely harsh" punishments for nondisclosure in tax returns. "While I agree that [Jaitley] should clamp down heavily on offenders, treating all offenders, small and big, first-time and repeat, in the same harsh manner is a bit much," Fazelbhoy said.

Ashish Sodhani of Nishith Desai Associates acknowledged that the budget tax provisions provide investor flexibility and improve India's business climate. However, some provisions may lead to ambiguity, he said.

"For example, the date for determining the value of the asset under the indirect transfer tax provisions may result in ambiguity in cases where intangibles were being transferred," Sodhani said. He also pointed out that the PE exemption for fund managers has several strict criteria that are impossible for private equity funds to meet and difficult for foreign portfolio investors to satisfy.

The majority of practitioners praised the government's acceptance of the recommendations to provide further clarity for nonresidents involved in indirect transfers of Indian assets. "Unfortunately, contrary to expectations, the budget does not contain any proposal to provide relief to taxpayers already in litigation on this matter," said Ravishankar Raghavan of Majmudar & Partners.

He noted that the government did not adopt some of the recommendations relating to tax exemptions for the transfer of listed securities and participatory notes and the availability of treaty benefits on such indirect transfers.

Although some of the proposals may cause concern, "the overall message from the budget is positive and should support India's case to be viewed as an attractive investment destination," Mandavia said.

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