This article captures tax implications for the international business community, in so far as the proposed changes announced in India’s budget for financial year 2021-22. 

The budget has been widely appreciated and overall reinforces the Indian government’s vision to make its tax administration transparent and efficient with slew of measures to address the dispute resolution mechanism for creating an enabling environment for investment and employment. 

However, with regards to equalisation levy on digital transactions, the rationalization proposals seems to have broad-based the levy and could potentially create created more controversies.  Some of the key proposals of the budget are discussed hereunder:

Equalisation Levy

India’s digital tax levy was expanded by its Finance Act 2020 to cover a range of digital transactions, which were taxed at two per cent of the gross value.  

This opened a Pandora’s box – leading to a flurry of reaction from the digital players and an adverse finding report from the Office of the United States Trade Representative (USTR 301 report) labelling it as discriminatory levy.  The report inter alia  lists the expansive scope of India’s levy as compared to other countries.  Budget 2021 has proposed some clarity with retrospective effect from 1 April 2020.

In a welcome move, it proposes that income by way of royalty or fees for technical services (taxable otherwise under the Income-Tax Act) will not attract equalisation levy.  

However,  the levy’s scope has been expanded to cover other online activities, retrospectively from April 1, 2020 including physical transactions which have been partly transacted online.  

Further, it has been clarified it is not mandatory for the e-commerce operator to own the goods or render services on the platform for application of this levy, meaning all intermediaries are covered.

For instance, an e-commerce operator which is operating as a market place (neither purchases nor sells) would be liable for the entire transaction value and not just the value of commission on the transaction.

Introduction of a definition for “liable to tax”

With an intent to bring clarity and consistency, the Budget has proposed to define the term ‘liable to tax’ which has significant implications and context.  

The previous budget had amended income tax law to bring stateless income of Indian citizens in the tax net. This amendment deemed Indian citizens to be tax residents in India in a case they were not ‘liable to tax’ in any other country or territory. In the absence of the definition, the term ‘liable to pay tax’ (legal situation) could be confused with payment of tax (factual situation).

The settled law in India emanating from an Apex court’s judgement states that the two situations are different and even if a person does not pay any tax due to an exemption, he will still be liable to tax in that jurisdiction. 

The earlier contention of taxpayers that a potential future tax liability in a country to cover ‘person liable to tax in that country’, can now be negated by the new definition.

Also, Indian tax treaties use the term ‘liable to tax’ (generally under Article 4(1)) in the context of tax residency. The revenue authorities were compelled to refer to case laws or international norms while applying the treaty. With the proposed definition, India has clarified its intent & position.

The manner in which the definition has been proposed however suggests that the threshold could be lower than  envisaged under generally accepted international tax principles, thereby providing access to treaty benefits more seamlessly.

New mechanism for advance ruling unveiled

The existing Authority for Advance Ruling (AAR) was often critiqued the long wait period associated and its functioning in past decade has been a source of disillusionment.  This was often a result of judicial & administrative vacancies arising due to unavailability of eligible members.

The  2021 Budget has proposed to abolish AAR by replacing it with a new Board for Advance Rulings (BAR). This change will now encourage taxpayers to approach the BAR for timely determination of their tax positions, akin to public ruling.

There are questions raised with regard to the independence of the authority, given that it would be led by senior tax officials and that orders of the authority can be appealed by the tax administration before the High Court.

Liberalisation of conditions for tax benefits to sovereign wealth funds (SWF) and pension funds (PFs) on their Indian investment

Since April 1, 2020, Sovereign Wealth Funds and Pension Funds are exempted from paying tax on income in the nature of capital gains, dividend and interest from investment made in specified infrastructure projects, , subject to certain conditions.  In a welcome step to attract foreign investment in infrastructure sector, Finance Bill, 2021, has proposed to liberalise the conditions to make the incentives more attractive.

This will address the difficulties faced by many SWFs in complying with the existing conditions, particularly on pooling investment vehicles, undertaking commercial activities and other form of eligible PF’s who enjoy an exempt status in foreign jurisdictions.  

Foreign portfolio investors now can take benefit of lower withholding tax rate as per the treaty

Indian tax laws mandate tax deduction at 20% (plus surcharge and additional cess) on dividend paid to Foreign Institutional Investors (“FIIs”) in view of a specific provision of the Income-tax Act, 1961. FIIs would welcome that Finance Bill 2021 has proposed laws to give benefit of a lower withholding tax on the basis of treaty entitlements, subject to furnishing of Tax Residency Certificates.

No withholding tax on dividend distribution to InvITs/ REITs

Income from Indian SPVs controlled by Infrastructure Investment Trust (InvITs) and Real Estate Investment Trust (REITs) are exempt from tax in India. Finance Act, 2020 introduced a dividend withholding regime from April 1, 2020  making dividends taxable in the hands of shareholders. Consequentially, Indian companies are required to deduct tax at the time of distributing dividends even though it is exempt in the hands of recipient, InvITs/REITS, thereby creating an anomaly.

The proposed amendment expands to address this situation by carving out payees where withholding obligation will not be applicable due to pass-through status.

More importantly, the changes are retrospective in order to extend benefit to InvITs/REITs forthe earlier financial year.

Rationalisation of MAT provisions

Amendments have been proposed to liberalise MAT provisions. As a rationalization measure, a change is made to reflect secondary adjustments or APA adjustments made for prior years in current year’s income.

For the years in which taxpayer has paid corporate tax and as a result of APA/Secondary adjustment, additional corporate tax liability arises, taxpayer now can apply to avail the  beneficial effect for such adjustments to the book profit. This will ensure that a taxpayer is able to utilise the tax paid for such years which could have lapsed.

Additionally, it had been proposed that dividend income of foreign corporate shareholders will suffer MAT. A proposal have been made to reduce dividend income from book profits in case of a foreign shareholders, where treaty offers a reduced tax rate compared to MAT i.e., 18.5% plus applicable cess and surcharge.

Slump sale and depreciation on goodwill

In another noteworthy amendment which impacts not just the international but also the domestic business community, the budget provides that no depreciation shall be provided on goodwill acquired. 

This is a further step towards providing clarity – depreciation on goodwill was an often litigated topic.  This may however impact the financial projections of investors which factored in goodwill amortization and hence, to that extent, this change impacts past transactions.

Similarly, slump sale provisions have been amended to provide all kinds of transfers, whether in cash or for non-cash such as exchange shall be taxable. Beneficial interpretation of the provisions by the Indian judiciary led taxpayers to exclude slump sale by way of non-cash deals as not liable to tax.

Others

Several clarifications & concessions shall benefit offshore banking activities in the International Financial services and exemption from lease rental paid for cross-border aircraft leading shall positively impact domestic airlines.

As a parting note, on the non-tax and economic front, the budget has significantly sought to revive growth by providing a slew of fiscal incentives and budgetary allocations with host of amendments triggering aggressive privatization of strategic & non-strategic Government companies & banks, monetising land parcels by creating SPV’s, consolidating 4 legislations into a securities code & measures to improve functioning of corporate bond markets, besides raising the FDI limit on insurance from 49 to 74%. 

At the same time, on the tax front the budget has made further progress towards aligning India’s tax regime with international best practices seeking to provide clarity on often disputed terms, thereby improving India’s image as an investment friendly destination. 

(Surekha Debata, Managing Associate and Sumeir Ahuja, Associate, of BMR Legal contributed to this article)