In a nutshell, the government has attempted to pay heed to the consumption slowdown and reduced the personal income tax rates up to INR1,500,000, which should give more money to wage earners. Further, dividend distribution tax has been done away with, and tax on dividends has to be paid by the shareholder. This will help foreign companies, who can take recourse to lower rates under their respective tax treaties. However, e-commerce companies have to withhold 1% tax on payments made by them to goods and services suppliers on their platforms above INR500,000. Moreover, the residency limit of 182 days has been reduced to 120 days, and a 10% tax at source has been levied on amounts greater than INR700,000 remitted out of India under the liberalized remittance scheme. The latter change may impede the free flow of capital for overseas investments by Indian residents under the liberalized remittance scheme.
The Finance Bill will be discussed in Parliament before its enactment, and therefore, it is likely that the Finance Bill may be amended as a result of these discussions. Once enacted, unless specified otherwise, most of the income tax proposals in the Finance Bill will be effective from the financial year commencing on April 1, 2020. We have summarized below some of the key policy and income tax proposals made in the Budget with our critique.
Income tax – reduced personal tax rates
A new optional personal income tax regime has been introduced in the Finance Bill. The personal tax rates have been summarized below and can be availed of by an individual taxpayer only if the individual taxpayer agrees to let go of all tax deductions or exemptions (such as house rent allowance, leave travel, transport allowance, standard deductions etc.,) that are available in the Income-tax Act, 1961 (the “IT Act”).
The personal tax rate changes appear attractive; however, the final tax calculations may turn out disadvantageous if the individual is availing tax deductions and exemptions. It is not clear whether the proposed tax simplification will have the same impact for everyone.
Removal of dividend distribution tax (“DDT”)
Under the current provisions of the IT Act, in addition to corporate income tax payable by an Indian company, any amount that is declared, distributed or paid by way of a dividend to a shareholder is charged to additional DDT at the rate of 20.56%. The Finance Bill has proposed to carry out amendments in various provisions of the IT Act so that an Indian company will not pay DDT; rather, dividend income will be considered taxable only in the hands of the shareholder. This amendment will take effect from April 1, 2020. Please refer to our update on Union Budget 2022-2023 which covers the latest legal position on the rate of tax on dividends received from foreign subsidiaries.
DDT is charged in the hands of the Indian company and is not treated as a tax withholding. It is not tax deductible and the Indian company actually pays 20.56% tax on its distributable profits on which it has already paid around 34% income tax. India treats dividends as tax-free in the hands of the shareholder if DDT has been paid; however, as the DDT has not been paid on the shareholder’s account, the foreign shareholder is unable to claim a DDT credit in its home jurisdiction. Foreign investors will now be liable to pay tax on divident in India at the rate of 20% under the IT Act or at the rate specified in the respective tax treaty. Thus, the effective dividend taxation rate for foreign companies will be between 5% to 20%, and the foreign company will be able to claim a tax credit, which is a positive move.
Foreign companies exempted from filing returns in India
Under the provisions of the IT Act, a foreign company is not required to furnish its return of income if its total income consists only of dividends or interest income and the withholding tax on such income has been deducted; however there is no relief for those foreign companies whose total income consists only of royalty income or fees for technical services. The Finance Bill has proposed to amend the relevant tax provisions to provide that a non-resident shall not be required to file a tax return if: (i) its total income consists of only dividend or interest income (as explained in the IT Act) or royalty or fees for technical services; and (ii) the tax withholding on such income has been appropriately made. This amendment will take effect from April 1, 2020. The additional exemptions from filing a tax return will ease the cumbersome tax compliance burden for foreign companies in India.
Widening the scope of withholding tax on e-commerce transactions
In order to widen the tax base, the Finance Bill has proposed to insert a new provision in the IT Act to levy withholding tax at the rate of 1% as follows: (i) The 1% tax should be paid by the e-commerce operator for the sale of goods or provision of services facilitated through its digital or electronic facility or platform; (ii) the e-commerce operator will be required to deduct tax at the time of credit of amount of sale or service or both to the account of the e-commerce participant or at the time of payment to such participant by any mode, whichever is earlier; (iii) the 1% tax is required to be deducted on the gross amount of such sales or services or both in excess of INR500,000. This amendment will take effect from April 1, 2020. The tax withholding requirement will increase the tax compliance burden of e-commerce operators. Third party sellers on e-market places may face a liquidity squeeze as companies like Amazon India and Flipkart will withhold an additional 1% while making payments to merchants who sell their goods or services on their platforms. While this may not impact consumers in terms of the final pricing of products, the proposal will surely rquire sellers to work-around their working capital requirements. Find our more detailed analysis of the enacted provisions of withholding tax on e-commerce transactions, here.
Tax collection at source on foreign remittances through the Liberalised Remittance Scheme (“LRS”)
The IT Act provides for collection of tax at source (“TCS”) on certain businesses. In order to widen the tax net, the Finance Bill has proposed to levy TCS on overseas remittances. So, an authorised dealer bank who receives an amount or an aggregate of amounts that is greater than INR700,000 in a financial year for remittances outside India under the LRS scheme shall be liable to collect TCS at the rate of 5% on amount that is in excess of INR700,000. In case where the remitter does not have a permanent account number or an Aadhar number the rate of tax will be 10%. This amendment will take effect from April 1, 2020. TCS on LRS remittances is unexpected as it makes investments of Indian residents (which are out of tax paid monies) outside India subject to tax with no tax credit mechanisms in place, effectively double taxing income.
Modification of residency requirements
The provisions of the IT Act inter alia provide for examples/situations where an individual is considered to be an Indian resident. Generally, if an individual has been in India for a period of 182 days in a financial year or for a period of 365 days or more within the four (4) years preceding that year, he is a resident and gets taxed on his global income. The Finance Bill has proposed that the residency period be decreased from 182 to 120 days. This amendment will take effect from April 1, 2021. This is an anti-abuse provision to check Indian citizens shifting their stay to low or no tax jurisdictions to avoid payment of tax in India. Additional clarifications are awaited on this proposal.
Reduced rate of 15% tax for manufacturing companies extended to companies engaged in generation of electricity
The provisions of the IT Act provide that new domestic manufacturing companies set up on or after October 1, 2019, which commence manufacturing or production by March 31, 2023 can opt to pay tax at a concessional rate of 15%, subject to the condition that such companies do not avail of any tax incentives or tax deductions. For this purpose, it has been clarified by the tax authorities that businesses engaged in the development of computer software, mining, conversion of marble blocks into slabs, bottling of gas into cylinder, printing of books or production of cinematograph films will not be considered as manufacturing or production.
On the basis of representations received from some stakeholders, the Finance Bill has extended the concessional tax benefit to the business of generation of electricity, which otherwise may not have been regarded as manufacturing. This amendment will take effect from April 1, 2020, and will benefit new power projects, especially upcoming renewable energy projects.
Increase of the safe harbour limit to 10% for land deals
Certain provisions of the IT Act inter alia provide that where the consideration received from the transfer of land or building or both is less than the value adopted by a stamp valuation authority for the purpose of stamp duty payment, the value so adopted shall be deemed to be the full value of consideration for computing business profits from the transfer of such assets. If the stamp duty value that is adopted by the authority does not exceed 105% of the consideration, the consideration actually received shall be deemed to be the full value of the consideration. Thus, the current provision provides for a 5% safe harbour. The Finance Bill has proposed to increase this to 10%. This amendment will take effect from April 1, 2021. This is a positive proposal to reduce the scope for tax litigation.
Delayed tax on Employee Stock Option Plans (“ESOPs”)
ESOPs have been a significant component of the compensation for employees of start-ups as they enable the retention of highly talented employees. Currently, ESOPs are taxed at two stages: (i) firstly, as perquisites when the shares are allotted or transferred to the employee; and (ii) secondly, as capital gains when the shares are sold by the employee. Given that the employer is required to withhold taxes on the perquisite amount, the Finance Bill (in order to minimize cash flow) has proposed to defer the payment of withholding taxes to within fourteen (14) days: (i) after the expiry of forty-eight (48) months from the end of the relevant assessment year; (ii) from the date of the sale of such shares by the employee; or (iii) from the date on which the individual ceases to be the employee, whichever is the earliest. This amendment will take effect April 1, 2020. The deferment of taxes on ESOP will be a stimulus to start-ups and aid in their growth.
Our tax team is available to assist you or your clients on any clarifications or tax impact assessment.