JULY 16, 2014

By Sudhir Nayak, Sudit K Parekh & Co

THE maiden budget of Sh. Arun Jaitely is laying a broad policy framework of the government giving the direction of the areas in which they desire to promote. This budget also reflected the lack of time available for the budget presentation as no fresh ideas have come in this budget.

The focus has been on Infrastructure, Real Estate and Power sector. Further also encouraging investment in these sectors through the introduction of Real Estate Investment Trusts (REITS) or Infrastructure Investment Trust (IIT) is a welcome move to ensure that funds are available for this sector. The continuation of the lower withholding tax on the issue of Bonds to overseas persons is a welcome move to garner funds for this sector. Further some relaxation is made for the FDI in the real Estate sector to boost that sector.

To provide impetus to FDI in certain specified sector like Defence and Insurance the limit for foreign holding has been increased from 26% to 49% with the FIPB approval and Management control remaining with the Indian partner.

On the Financial sector front some good initiatives have been taken of having a common KYC for all financial products and enactment of India Financial Code, expanding Debt Recovery Tribunal in more cities to expedite the process of recovery from loan defaulters.

Also some initiative is taken to promote shipping sector by promoting new ports and also to promote inland waterways. A very good initiative is on Food Security front to reduce the Transmission and distribution loss.

Taxation Related Amendments

On the Tax front what could have been done is to provide clarity on the retrospective amendments on Indirect transfer, especially when the BJP government had stated in clear terms that they were against retro amendments to the fiscal laws. Also no framework has been laid down for the resolution of the existing disputes which are in courts today and no sign of reconciliation is visible. However a mechanism has been laid that all cases where action are taken based on retrospective amendments will be scrutinized by the High level Committee of the apex tax authority (CBDT) before initiating action. We will have to see how this high level committee of senior officers operates in reality. The initial experience of tax payers with the Dispute Resolution Panel was mixed as the powers of the panel on taking critical decisions was hindered by the process and also with the past history of litigation in the cases.

On the tax litigation front some good measures have been initiated to expedite the process by allowing Residents to apply for Advance Ruling and also by enlarging the scope of Settlement Commission for dispute resolution. However in the fine print it was not evident.

The relevant amendments proposed in the budget on the direct tax front are listed below:

1. Characterisation of Income of Foreign Institutional Investor(FII)

With a view to provide clarity on taxation of income earned by Foreign Institutional investor and to give impetus to capital markets, the Finance Minister has amended the definition of capital asset to include any securities held by Foreign Institutional investor.

This would help a long way in settling the long drawn litigation on classification of income earned by FII's as capital gains as against tax departments view of treating them as business income.

This is a welcome move as this provides clarity on taxation to Foreign investors and would result in boosting capital markets inflow.

2. Taxability of Debt oriented mutual funds and unlisted securities.

Till date share of a company, listed securities and unit of mutual fund were considered as long term capital asset if the period of holding was more than 12 months.

However, now it is proposed that share of a unlisted company and units of a mutual fund (excluding units of equity oriented mutual fund) would be considered as a long term capital asset only where the same are held for 36 months

3. Investment Allowance

Last year to provide an impetus for industrial growth a deduction of 15% on acquisition of new plant and machinery was allowed to tax payers engaged in the manufacture or production where the amount of investment was above INR 100 Crores spread over a period of 2 years.

The Finance Minister in his budget has extended this benefit to the small tax payers engaged in the manufacture or production where the amount of investment is above INR 25 Crores.

This should be considered as a welcome move as it would provide incentive even to smaller players in manufacturing industry to make capital investments as the limits of investments for claiming the deduction have been reduced considerably.

4. Investment Linked Deduction of Capital Expenditure

Benefit of investment linked deduction of capital expenditure which was presently available to 11 specified business (like cold chain facility , warehousing for agricultural produce or sugar , hospital with 100 beds, ICD/ CFS , housing project under SRA etc ) has now been extended to two new business - Slurry Pipe Line for Transportation of Iron Ore and semiconductor Wafer manufacturing unit. The capital expenditure should be used for the specified business only and in the event of such non use the deduction allowed earlier will be taxed as business income of the year in which the same is not used. However an exception is provided to a sick company.  

5. Indian Transfer Pricing regulations

The Finance Bill 2014 provides for amendment of Section 92B(2) to extend scope of deemed “international transactions” to transactions between the taxpayer and an unrelated domestic entity as well, that occurs as a result of a prior arrangement between the associated enterprise and such domestic entity.

This amendment aims at reversing the ruling of the Hyderabad Tax Tribunal in the case of Swarnandhra IJMII Integrated Township Development Company Pvt. Ltd. that states that transactions between Indian entities cannot be a deemed International transaction.

As widely sought by the tax professional and business fraternity, the Finance Bill, 2014 provides for a roll-back of Advance Pricing Agreements (APA). Accordingly, the arm's length price or the manner of determining the arm's length price as per the APA shall apply to international transactions entered into during period of four previous years preceding the first of the periods covered under APA. However, it is to be noted that such roll-back is subject to prescribed conditions, procedure and manner which are yet to be notified.

Roll-back of APAs would encourage more taxpayers to opt for this route as a tool of controversy management.

The Finance Bill 2014 has given powers to the Transfer Pricing Officer (TPO) to levy penalty on failure to furnish documentation or information as required under transfer pricing regulations that were hitherto available only to the Assessing Officer or Commissioner (Appeals). This would result into more powers in the hands of the TPO itself

The Finance Minister in his Budget Speech mentioned that a “range” concept for determining the arm's length price would be introduced as against the “arithmetic mean” currently followed. However, the arithmetic mean would continue to be used in cases where adequate comparables are not available.

The Finance Minister has also proposed to amend the regulations to allow use of multiple year data as against the existing rules allowing for use of only single year data for comparability analysis. This amendment should put to rest litigation on this front.

Though the above proposals are in line with global best practices, it is to be noted that there are no explanations/amendments in the Finance bill or Memorandum to Finance bill. One can expect more guidance on the finer points by way of a separate notification.

However, with the introduction of the above proposals one needs to wait and watch whether the tolerance band of 3% (or 1% in case of wholesalers) is done away with.

6. No capital gains on transfer of Government Security between two non residents

In order to boost trading of government securities, the Finance Minister in his budget has provided that any transfer of government securities (carrying a periodic interest) between two non residents would not be considered as a taxable transfer in India.

This would work as an incentive for Non residents to invest in government securities of India.

7. Tax on dividend received from Foreign Company

The Finance Minster with a view to encourage repatriation of funds by the foreign subsidiary of the Indian company introduced section 115BBD on 1 st April 2012, wherein a concessional tax rate of 15% instead of 30% was provided for taxability of dividend in the hands of the Indian Company.

The said provision was extended on year on year basis from 1 st April 2013 till 31 st March 2014.

Now, the Finance Minister has extended this benefit without providing for any sunset date.

8. Allowance on expenses on which taxes have not been withheld

Earlier, where an Indian tax payer made any payment to a resident on which taxes were deductible, without deduction of taxes, the entire amount of expenditure was not allowed as deduction from its profits.

Given that the withholding tax rates prescribed are anywhere in the range of 1% to 25%, the disallowance of the entire expenditure was causing tremendous hardship on the tax payer.

The Finance Minister has taken this into consideration and has provided that only 30% of the expenses would be disallowed where the taxes have not been deducted. This is a welcome move for the tax payers.

9. Introduction of Real Estate Investment Trust (REIT) and Infrastructure Investment Trust (Invit)

The REITs and Invits would raise capital by way of issue of units (to be listed on a recognised stock exchange) and would also raise loans from residents and non residents. The income bearing assets would be held by the trust by way of acquiring controlling or other specific interest in an Indian Company (SPV) from sponsor.

The Finance minister has put in place a specific tax regime for taxability of income in the hands of the Trust and the taxability of the income received by the unit holder of the REITs and INVITs.

The taxability on sale of units of the REITs and INVITs would be taxed in the same manner as listed equity shares.

However, capital gains arising to sponsor at the time of exchange of shares of the SPV for units in the REIT and INVITs would get deferred till the time of sale of units. However, the sponsor would not be eligible for beneficial tax rates as available to the unit holders of the Trust.

Interest paid by the SPV to the Trust would be granted pass through status and there would be no withholding tax on the same. However, interest paid to the unit holder by the Trust would attract a withholding tax at 5% for non resident and 10% for residents.

The capital gains on disposal of the assets by the Trust would be taxed only in the hands of the Trust. The capital gain income distributed by the Trust on which taxes are paid would not be taxed in the hands of the unit holder. Any other income of the trust would get taxed at the maximum marginal rate.

Dividend received by the trust would be liable to DDT at the SPV level. Accordingly, dividend distributed by REITs and INVITs to the unit holder will not be taxable.

In case where ECB is taken by the trust, the benefit of reduced rate of 5% on interest payment to non resident lenders would be available.