India’s Union Budget (the “Budget”) was announced on February 1, 2018, and the Finance Bill, 2018 (the “Finance Bill”) was tabled in Parliament. Most of the income tax proposals in the Finance Bill will be effective from the financial year commencing on April 1, 2018, unless specified otherwise. 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.
We have summarized below some of the key income tax proposals.
Corporate Tax Rates
The corporate income-tax rate has been reduced to 25% (from 30% earlier) for Indian companies whose total turnover or gross receipts do not exceed INR2.5billion (approx.US$39.3 million). Although the expectation was that the Finance Bill would lower the corporate tax rate to 25% across the board, including for limited liability partnerships and partnership firms, the Finance Minister has restricted this benefit only to very small and medium sized enterprises. In our view, the continued high tax regime (as provided in the Table below) may impact investment flows as developed economies like the US are now offering significantly lower corporate tax rates and a more stable tax regime. In addition, for the financial year 2018-19, an extra surcharge called the “Health and Education Cess on income-tax” will be levied at the rate of 4% on the amount of tax computed.
|Type of company||Income up to INR10 million||Above INR10 million up to INR100 million||Above INR100 million|
|Surcharge||Effective tax rate||Surcharge||Effective tax rate||Surcharge||Effective tax rate|
|Domestic with turnover (or gross receipts) not more than INR2.5 billion in the FY 2016-17||Nil
|New domestic manufacturing||Nil
|Note: Health and education cess of 4% has been considered for determining the tax rates above. For existing tax rates, education cess and secondary and higher education cess of 3% has been considered. Figures in brackets represent existing tax rates.|
Long Term Capital Gains on Sale of Listed Equity Shares
Under the existing provisions of the Income-tax Act, 1961 (the “IT Act”), there is no long term capital gains tax on the transfer of equity shares of a listed company, or units of equity oriented funds or business trusts, which are subject to payment of Securities Transaction Tax (“STT”) at the time of sale and acquisition (except for certain acquisitions covered by a notification). The Finance Bill proposes to withdraw this exemption and provides that long term capital gains in excess of INR0.1 million (US$1,560) arising on the transfer of equity shares of a listed company, a unit of equity oriented fund or a unit of a business trust shall be taxed at 10% (without indexation). Indexation refers to a method of calculation that allows you to increase the purchase price using the Cost Inflation Index. This will also apply to Foreign Portfolio Investors. The impact of the tax may not be significant due to the grandfathering clause which is available for shares purchased up to January 31, 2018. Further, the cost of acquisition of the equity shares of a company, or units of an equity oriented fund or a business trust acquired by assessee prior to February 1, 2018, shall be the higher of the following: (a) the actual cost of acquisition; and [sic] (b) the lower of (i) fair market value on January 31, 2018; and [sic] (ii) full value of consideration received or accruing as result of transfer. Please see the illustration below for more clarity.
|Circumstances||Fair Market Vale|
|If the capital asset is listed on a recognized stock exchange||Highest price of capital asset quoted on such exchange on January 31, 2018|
|If there is no trading in the capital asset on a recognized stock exchange on January 31, 2018||Highest price of such asset on such exchange on a date immediately prior to January 31, 2018 when such asset was traded|
|In case where a unit is not listed on a recognized stock exchange||Net asset value of such asset as on January 31, 2018|
|Purchase of shares on January 1, 2017||1,000,000|
|Sale of shares on March 31, 2018||2,000,000|
|Fair market value of shares on January 31, 2018||1,500,000|
|Long term capital gains is tax exempt because the sale is before April 1, 2018|
|Purchase of shares on January 1, 2017||1,000,000|
|Sale of shares on April 1, 2018||2,000,000|
|Fair market value of shares on January 31, 2018||1,500,000|
|Fair market value of the shares as on January 31, 2018 to be the cost of acquisition as per the grandfathering provision.|
The amendments will be effective from April 1, 2018 and will apply to assessment year 2019-20 and all subsequent assessment years.
The introduction of long term capital gains tax of 10% on listed securities was expected, as this tax is levied in many countries. According to the Finance Minister, INR300,000 crores (US$46.86 billion approximately) of long term capital gains tax on listed securities transactions, was too large a number to ignore. The impact of the tax may not be significant due to the grandfathering clause which is available for shares purchased upto January 31, 2018 as shown in the illustration above. However, compliance requirements for non-residents may become onerous, as they will have to file a tax return on such long term capital gains income (that was tax exempt earlier) with the Indian income tax authorities, exposing themselves to tax audit scrutiny that could be time consuming and costly. Additionally, there is no relaxation in cases of acquisition of shares through a preferential allotment, or on account of a merger, amalgamation, gift or inheritance. Having said that, with every new tax provision that is introduced, there is bound to be a set of accompanying complex issues, which we hope will be sorted out in due course.
Accumulated Profits – Deemed Dividends
Under the provisions of the IT Act, “dividend” includes distribution of accumulated profits to its shareholders by a company, be it in the nature of: (a) release of assets; (b) debenture issue or bonus distribution to its preference shareholders; (c) distribution of proceeds on liquidation; (d) reduction of capital; or (e) in the case of an unlisted company, any loan or advance given to a shareholder having a shareholding of 10% or above, or to a concern in which such shareholder holds substantial interest (exceeding 20% of shareholding or interest), or any payment by such company on behalf of or for the individual benefit of such shareholder. Due to instances of abusive arrangements (where companies with large accumulated profits adopt the amalgamation route to reduce capital), the Finance Bill has proposed to widen the scope of the term “accumulated profits” such that dividend distribution tax will be applicable on accumulated profits of an amalgamating company post amalgamation. This amendment will be effective from April 1, 2018.
Dividend Distribution Tax – Deemed Dividends
Currently, under the provisions of the IT Act, deemed dividend in the nature of loans and advances given by a company (in which the public are not substantially interested) to its shareholders is taxed in the hands of the recipient at the applicable rate of tax. Such deemed dividend was excluded from the scope of dividend distribution tax in the hands of company providing such loans and advances. The Finance Bill has proposed to include such deemed dividends within the scope of dividend distribution tax under Section 115-O of the IT Act at the rate of 30% without grossing up. This amendment is proposed to be applicable to all such transactions of deemed dividend undertaken on or after April 1, 2018.
Dividend Distribution Tax – Dividend payouts to unit holders in an Equity Oriented Fund
Under the provisions of the IT Act, any income that is, inter alia, distributed by a mutual fund to its unit holders is chargeable to tax, and the mutual fund is liable to pay additional income tax on such distributed income at the rates specified. However, income that is distributed to a unit holder of an equity oriented fund is not chargeable to tax. In order to provide a level playing field between growth oriented funds and dividend paying funds, given the new capital gains tax regime for unit holders of equity oriented funds, it is proposed that where income is distributed by an equity mutual fund, the mutual fund shall be liable to pay additional income tax at the rate of 10%. This amendment will take effect from April 1, 2018.
Entities needing Permanent Account Number
The Finance Bill has proposed that every person (not an individual) who enters into a financial transaction of an amount aggregating INR250,000 (approx. US$3,900) or more in a financial year shall be required to have a Permanent Account Number. Further the managing director, director, partner, trustee, author, founder, chief executive officer, principal officer or office bearer or any person competent to act on behalf of such an entity will also have to obtain a PAN. The amendment will apply from April 1, 2018. In our view, this will create an onerous compliance issue for non-resident entities entering into financial transactions (not defined) with Indian entities where there is no income chargeable to tax for the non-resident entities in India.
Business Connection – Permanent Establishment
Under the existing provisions of the IT Act, the term “business connection” includes business activities that are carried on by a non-resident in India through dependent agents. The scope of “business connection” under the IT Act is similar to the provisions relating to a Dependent Agent Permanent Establishment (“DAPE”) under India’s Double Taxation Avoidance Agreements (“DTAAs”). In terms of the DAPE rules in the DTAAs, if a person acting on behalf of the non-resident is habitually authorized to conclude contracts for the non-resident in India, then such agent constitute a permanent establishment (“PE”) in India. However, in many cases, to avoid a PE, the person acting on the behalf of the non-resident negotiates the contract but does not conclude it. In order to tackle such tax avoidance, the Finance Bill has proposed that an agent shall include not only a person who habitually concludes contracts on behalf of the non-resident, but also a person who habitually plays a principal role leading to the conclusion of contracts. This amendment will take effect from April 1, 2018.
Significant Economic Presence
The Finance Bill seeks to tax the digital economy by clarifying that a “business connection” shall include a “significant economic presence.” What this means is that a non-resident can have a taxable presence in India if the non-resident’s digital enterprise has a significant economic presence in India on the basis of factors that evidence a purposeful and sustained interaction with the Indian economy via technology or other automated tools. This may impact companies like Facebook, Snapchat and others who derive digital advertising revenue from India, which is not captured by the IT Act. As the Indian government works on the finer details of the new nexus rules, it will need to address issues such as, determining the income attributable to a significant economic presence and its interaction with the equalization levy. This amendment will be effective from April 1, 2018.
Taxability of compensation received on termination of a contract
The Finance Bill proposes to tax any compensation or other payment due to or received by any person in connection with the termination or the modification of the terms and conditions of any contract relating to his or her business as business income as a revenue receipt and not as a capital receipt. The amendments will be effective from April 1, 2018.
Conversion of stock-in-trade into capital asset
The provisions of the IT Act provide for taxability on conversion of a capital asset into stock-in-trade; however, there is no provision to tax conversion of stock-in-trade into a capital asset. The Finance Bill proposes to provide symmetrical treatment by taxing the conversion of stock-in-trade into a capital asset as business income at the fair market value as on date of conversion as determined in the prescribed manner. This amendment is proposed with effect from April 1, 2018.
Facilitating insolvency resolution
Currently, under the provisions of the IT Act, losses of a closely held company are allowed to be carried forward and set off only if the shareholders who beneficially hold at least 51% of the voting power on the last day of the previous year in which loss was incurred continue to hold their shares until the last day of the previous year. Restructuring of companies seeking resolution under the Insolvency and Bankruptcy Code, 2016, generally involves a change of the majority shareholder. The Finance Bill proposes to provide relief to such companies by providing that carried forward losses shall not lapse on change of the beneficial shareholding of 51%. However, this benefit can be obtained only after discussion with the jurisdictional Principal Commissioner of Income Tax. It is unclear whether a written approval is needed, which should be clarified. This amendment is proposed with effect from April 1, 2018.
Measures to promote start-ups
Currently, under the provisions of the IT Act, a deduction of 100% of the profits and gains derived from eligible business is available to a start-up for any three (3) consecutive assessment years out of seven (7) years, beginning from the year in which the eligible start up is incorporated, subject to prescribed conditions. The term “Eligible start up” has been defined to mean a company or LLP engaged in an eligible business which fulfills the following conditions, namely: (a) it is incorporated on or after April 1, 2016 but before April 1, 2019; (b) the total turnover of its business does not exceed INR250 million (approx. US$3.9 million) in any of the financial years beginning on or after April 1, 2016 and ending on March 31, 2021; and (c) it holds a certificate of eligible business from the Inter-Ministerial Board of Certification as notified in the Official Gazette by the Central Government.
“Eligible business” for the purpose of claiming this tax holiday benefit has been defined to mean a business which involves innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property. In a welcome move, the Finance Bill proposes to improve the effectiveness of the scheme for promoting start-ups in India by making the following changes in the taxation regime for start-ups: (a) the benefit will also be available to start-ups incorporated on or after April 1, 2019 but before April 1, 2021; (b) the requirement of the turnover not exceeding INR250 million (approx. US$3.9 million) will apply to seven (7) previous years commencing from the date of incorporation; and (c) the definition of “eligible business” has been expanded to provide that the benefit will be available to start-ups engaged in innovation, development or improvement of products or processes or services, or a scalable business model with a high potential of employment generation or wealth creation. The proposed amendment is applicable from April 1, 2018.
The Budget has the contours of both, work-in-progress and a new vision for the future. Overall, the Budget seems to be positive and has maintained a balance between governance, the economy and development. Negotiating political necessities without affecting the government’s finances is a tough task. The Budget also seeks to give a much needed impetus to rural growth by promoting agriculture, healthcare, education, employment generation, infrastructure and defence while balancing the fiscal deficit.