Direct tax proposals focus on providing impetus to an economy that has slowed
July, 14th 2014
The Finance Minister presented his maiden budget within about 45 days of formation of the new Government. The proposals are directed at giving a much-needed thrust to a slowed down economy. FDI in insurance, defence and real estate sectors are liberalised. Certainty in the tax regime is intended to be brought in.
The key proposals are: * Exemption ceiling raised by Rs 50,000 for all individual taxpayers excluding super senior citizens * Deduction for interest on housing loan for self occupied property raised by Rs 50,000 * Deduction for tax savings schemes increased by Rs 50,000
These are token benefits for individuals but would result in major foregoing for the national exchequer in these difficult times. The measure should see larger tax compliance. The new threshold, though, is equal to that in the US.
Unlisted securities held upto 36 months would henceforth be treated as short term capital asset, increasing capital gains tax rate by about 10 per cent. Capital gains on ESOPs of foreign companies would be negatively affected.
There are several measures for economic growth -
Investment Allowance Companies in the manufacturing sector can avail investment allowance at 15 per cent if the cost of the plant and machinery installed during the year is more than Rs 25 crore. This benefit would be available for investments made upto 31.3.2017. Under the current law, effective 2013-14, the threshold was Rs 100 crore over two years and the benefit was available upto 31.3.2015. The new benefit is mutually exclusive to the existing regime for FY 2014-15.
This measure can result in deduction of upto 50 per cent of the cost of plant and machinery in the year of investment.
There is a grey area on carry forward. Even if treated as part of the business loss, it can be carried forward only upto 8 years whereas depreciation can be carried forward indefinitely.
Real Estate Investment Trust and Infrastructure Investment Trust
The REIT/InvIT structure would be as under-
The Finance Bill proposes single stage taxation for income from REITs/InvITs. Investors would be taxable on interest income and capital gain on transfer of units of REITs/InvITs. Other income like capital gain (on transfer of shares of SPV) would be taxed in the hands of the trust but exempt for the investor when distributed. Listed units of the trust would be treated at par with listed shares for capital gains tax. Migration of shares from direct holding structure to REIT/InvIT is tax neutral.
REIT/InvIT brings in access to capital market for the investors as well as the beneficial capital gains regime for listed securities. The single stage taxation may not be achieved in case a foreign investor cannot get credit in its home country for tax paid by REIT/InvIT.
Tax holiday for new power projects
New power projects enjoy 10-year tax holiday. However, the existing provision required the commencement of power production within 31.3.2014. The sunset clause is now extended up to 31.03.2017. The extension would encourage setting up of power plants. However given the long construction period, three years may not be enough for mega power projects.
Investment linked deduction
Upfront 100 per cent deduction for investment in capital assets for specified industries will additionally apply to business of slurry pipelines for iron-ore transportation and semiconductor wafer manufacturers.
New anti-abuse provisions require mandatory use of the assets for a minimum 8 years in the specified business failing which benefit claimed in excess of eligible depreciation would be taxable. The current provision for taxation of amount received on sale of the asset, as business income, would continue. The deduction has been made mutually exclusive with tax holiday for SEZ units.
Measures have also been proposed to bring in certainty in tax laws and reduce litigation:
Advance Pricing Agreements
With an intention to reduce TP litigation, APA was introduced in 2012. Signalling a further positive intent, it is proposed to introduce conditional rollback of APA settlement to cover 4 prior years' transactions. It is also proposed to strengthen the administrative set-up to expedite disposals.
Use of multiple year data and range for determining Arm's length price
The Finance Minister also proposed to introduce the concepts of range & multiple year data, instead of arithmetic mean & single year data respectively. Both the existing concepts pose significant challenges for the taxpayers. Arithmetic mean is influenced by extreme values in the data set which can be mitigated in the range concept. The biggest challenge for single year data is non availability of data at the time of comparability analysis vis-à-vis the data used by the TPO 3 years later. The proposals are in line with the global TP best practices and enshrined in the OECD TP Guidelines. The proposals have not been introduced in the Finance Bill.
The Finance Minister announced that resident taxpayers would be eligible to obtain advance ruling for income tax above a specified threshold. Relevant provisions do not appear in the Finance Bill. If introduced, this can definitely prevent repetitive litigation. Additionally, introduction of new Benches in the AAR is a welcome proposal but needs to be acted upon expeditiously to bring down the pendency.
The intended enlarging of scope of the Settlement Commission does not however find place in the Finance Bill.
Gains from transfer of Indian securities would necessarily be classified as capital gains. While this would bring certainty on the controversial issue of whether such income is 'business income' or 'capital gains', it also has negative consequences - (a) gains which were not taxable being business income without a PE in India would henceforth become taxable and (b) in case the fund manager is based in India creating a PE for the FII, the capital gains exemption under beneficial treaties (Mauritius, Singapore, etc.) may not be available.
However, the proposal to exclude income from principal business of trading in shares, from speculative income would definitely reduce litigation.
The Companies Act, 2013 imposes a responsibility on large corporates to spend on corporate social responsibility. Allowability of the outgo as a deductible business expenditure was a potential issue for litigation. The Finance Bill specifically bars tax deduction of CSR - putting a lid on the controversy. However, the deduction under Section 80G of the Income-tax Act for contribution to the Prime Minister's National Relief Fund continues. Further, the new proposal does not affect deductions under other provisions (like 35AC, 35CCD). Also, there is no disallowance under MAT.
The sunset clause for the beneficial 15 per cent tax on dividends from foreign subsidiaries has been removed bringing certainty to the provision.
Concessional tax rate
Interest on foreign currency loans and long-term bonds (taken upto 30.06.2017) would enjoy 5 per cent tax. The benefit was hitherto available upto 30.06.2015 and on loans and infrastructure bonds.
Some of the proposed provisions or the lack of it may prove to be retrograde, unless appropriate corrective measures are taken or appropriate safeguards are implemented.
The methodology for computing DDT would be changed for enlarging the computation base. DDT would be computed on grossed up basis on distributable income before reduction of DDT. This would increase the effective rate of DDT by about 3 per cent. Further, total tax outgo for a domestic company would be larger than a foreign company.
Applying similar proposals, the income distribution tax of debt oriented MFs would increase by 9-15 per cent.
Retroactive laws for taxation of overseas transfer of shares remain untouched. Status quo would be maintained for existing disputes and fresh cases would be scrutinised by a high level committee. The proposals may not be constitutionally valid on the ground of discrimination. Additionally, ambiguities in the existing provisions (on threshold and computation) need clarity. The Shome Committee's recommendations, if accepted, can address these issues.
The threshold for long term capital gain for unlisted securities and non-equity-oriented MFs will be enhanced from 12 months to 36 months. This would increase the tax (base) rate for affected transactions from 10/20 per cent to 30/40 per cent. This could significantly affect investments (exits) by PE funds.
Tax Computation and Disclosure Standards
It is proposed to notify standards to be followed for computing taxable income. Noncompliance may result in best judgment assessment. This proposal needs careful implementation. Otherwise, it may lead to contradiction with settled tax principles and improper application leading to prolonged litigation.
Several provisions are proposed in this regard, both substantive and procedural-
* The disallowance for non-deduction of tax (resident payee) would be reduced to 30% of the expenditure but would apply to all expenses - largely mitigates double jeopardy
* Similar disallowance for non-resident payee removed if tax paid before filing return
* Statutory timelines provided for withholding tax assessments - would reduce litigation on technical grounds
* TPO empowered to levy penalty for non-furnishing of information - a logical measure
* Deemed international transaction would include transaction between residents
The Finance Minister has taken policy decisions in line with the Government's efforts to revive economic growth even though the agenda remains unfinished. It needs to be ensured that there is hassle-free implementation too.