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New Tax Proposals in India Budget 2011
The backdrop leading up to the presentation of the annual Budget of the Government of India for fiscal year 2011-12 was punctuated by robust growth, high inflation and the issue of unaccounted money in tax havens and low tax jurisdictions. On the fiscal legislation front, the ground was being set for two key new enactments - the Direct Taxes Code ("DTC") and the Goods and Services Tax Act ("GST").
On the policy side, the standout proposal of the Government was to provide stimulus to investments in infrastructure with an outlay higher by 23 percent compared to last year. Foreign Institutional Investors ("FII") investment limits in infrastructure bonds will be permitted to raise foreign capital with interest payouts being subject to tax withholding only at 5 percent, down from the normal level of 20 percent. The Government is also set to announce a manufacturing policy, which is expected to provide further impetus to the economy. While reiterating the Government's intention to introduce the DTC effective 1 April 2012, the Government was more circumspect with regard to the implementation timelines for the GST. As a first step paving the way for GST, a Bill to amend the Constitution is proposed to be placed before Parliament in the current session.
Taxand India examines certain key tax proposals in the Finance Bill, 2011 ("the Bill") presented by the Indian Finance Minister on 28 February 2011, and discusses why taxpayers should revisit their existing business structures and models ahead of time in preparation for the DTC.
- The Bill proposes to reduce the surcharge payable by domestic and foreign companies from 7.5 percent to 5 percent and 2.5 percent to 2 percent respectively. Consequently, the effective rate of tax for domestic and foreign companies would be 32.445 percent and 42.024 respectively. The tax rates would apply to income earned during the period April 2011 to March 2012. The benefit of this reduction would be available for all companies.
- Minimum Alternate Tax ("MAT") applicable on book profits of companies is proposed to be increased from 18 percent to 18.5 percent, which results in an effective MAT rate of 20.008 percent with surcharge for domestic companies and 19.436 percent for foreign companies having a Permanent Establishment ("PE") in India.
- Dividend Distribution Tax ("DDT") rate would remain unchanged at 15 percent, while the effective rate would be marginally lower 16.223 percent, due to the reduction in surcharge.
Special Economic Zones
- The Bill proposes to end the exemption from levy of DDT available to the developers of Special Economic Zones ("SEZ"), which is in line with the proposals in the DTC. This benefit would be withdrawn with effect from June 1, 2011. Any dividend declared prior to this date would enjoy the exemption.
- The bill also seeks to withdraw the exemption from levy of MAT for SEZ developers and units. While the DTC proposals were to be effective from 1 April 2012, the Bill seeks to advance the roll back of the exemptions to 1 April 2011. Once this proposal is enacted, the developers and units would be subject to a MAT of 20.08 percent on book profits.
Sector specific incentives
- It is proposed to extend the investment linked incentives to affordable housing projects. Similar benefits are being extended to new investments for fertiliser production in India.
- The Bill proposes to extend the profit linked deduction for power generation, transmission or distribution by one more year, until the end of March 2012.
- Currently, the production of mineral oil or natural gas is eligible for a tax holiday for seven years from the year in which the commercial production commences. The Bill seeks to withdraw this incentive in respect of blocks licensed under contracts awarded after March 2011. This is in line with the amendment proposed under the DTC, where the sector would be allowed only an investment linked incentive.
Incentives for Infrastructure funding
- The Government proposes to set up infrastructure debt funds and the income of such funds would be exempt from tax. The interest paid by such funds to non-resident investors would be taxed at a lower tax rate of 5 percent, which is to be withheld at source. Simultaneously under the securities market regulations, cap on investments by FII on corporate bonds has been increased from USD 5 billion to USD 25 billion. The investments are subject to a minimum lock-in period of 3 to 5 years.
- Taxation of Limited Liability Partnerships ("LLP") is proposed to be brought on par with companies with an Alternate Minimum Tax ("AMT") of 18.5 percent on the adjusted income, which is to be computed by adding certain profits eligible for tax holidays to the regular taxable income. The proposal seeks to reduce the comparative advantage of LLPs over a company, which is liable to AMT on book profits.
- The Bill proposes that the AMT would be allowed as a deduction from tax payable by the LLP in the year in which the regular income tax is greater than AMT and to the extent of the difference between regular income tax and AMT. AMT credit would be carried forward for a maximum period of ten years from the year in which such credit arose. No interest would be payable on such carried forward credit.
- However, even after this amendment, LLP would remain an attractive form of business entity, as it continues to enjoy the exemption DDT.
Taxation of dividends from foreign subsidiaries
- Dividends declared, distributed or paid by foreign subsidiaries of Indian companies are proposed to be taxed in the hands of the Indian Companies at a lower rate of 15 percent on the gross value. It is specifically provided that no expenditure or credit allowance would be permited as a deduction. The proposal could be detrimental to leveraged buyouts or strategic long term investments where the interest or other expenditure would not be liable for deduction, while the dividend earned could be minimal.
Transfer Pricing changes
- The existing safe harbor range of 5 percent under Transfer pricing ("TP") provisions are proposed to be replaced with a new range of percentages to be specified.
- TP officers are to be empowered to audit any new transaction, which comes to notice during a TP audit even if such transaction was not originally referred for an audit.
- To discourage transactions with certain jurisdictions with which India does not have effective exchange of information agreements, the Bill proposes the following measures:
- Transactions with entities in such jurisdictions would be subject to TP regulations including the requirements to maintain adequate documentation to demonstrate that the transactions are at arm's length basis;
- Payments to such entities would be disallowed in computing the income of the taxpayer unless prescribed documents are maintained by the taxpayers. Further, where such entity is a financial institution incorporated in such a jurisdiction, taxpayer is required to furnish an authorisation enabling the Indian tax authorities to seek relevant information from the financial institution, to avoid disallowance;
- Taxpayers are required to withhold tax on such payments at the applicable rates or 30 percent, whichever is higher; and
- Where any sum is received by a taxpayer from such entities, such receipts would be deemed to be the income of the taxpayer unless a satisfactory explanation is provided as to the source of such sums.
Reporting requirements for Liaison Offices
- Non-residents setting up or operating liaison offices in India with the approval of the Reserve Bank of India would be required to file an annual information return on their activities, within 60 days from the end of the relevant financial year.
- Peak rates under customs, excise and service tax remain unchanged.
- Penalty provisions are to be made more stringent for offences such as concealment of particulars.
Customs and Central Excise
- Self assessment procedure is to be introduced for import and export. This will be subject to certain safeguards and conditions.
- Consideration payable for right to use packaged software or canned software (not requiring affixation of retail price) would be exempt from customs and excise duties. Duty would apply only on the value of software.
- Capital goods procured for expansion of 'mega power project' would be exempt from excise duty.
- The Bill proposes to levy the tax at the time of provision of services, billing or collection, whichever is earlier.
- Scope of existing taxable services such as business support services, health care, legal, life insurance services and commercial training is proposed to be widened.
- The procedure for availing refund of service tax or claiming exemption on services received by SEZ developers or units is proposed to be rationalised to make it more business friendly.
- Categorisation of certain services under the Export and Import Rules is proposed to be aligned with the global practices of taxing B2B transactions at destination and B2C transactions at origin.
Cenvat credit (Set off of taxes paid)
- Significant changes are proposed in the credit mechanism, which could have an overall impact of reducing the extent of credit available to taxpayers
- Cenvat credit is proposed to be allowed on (exempt) services provided to SEZ developers/ units. This would bring in tax parity between goods and services supplied to SEZ units/ developers
The broad thrust of the direct tax proposals are to pave the way for the DTC regime and usher in a stronger anti-avoidance regime with minimal tax incentives and a stable tax rate. The proposals do not address expectations on structural changes in tax administration considering that the taxpayers' experience, particularly in the areas of dispute resolution panel and TP audits. Measures such as the rollback of the MAT and DDT exemption to SEZ developers / units ahead of the timelines indicated earlier reduces certainty on tax positions for the taxpayers. On the indirect taxes front, the tax credit mechanism and penalty regime have been made more stringent, while leaving several aspects requiring clarifications untouched. An early introduction of GST is needed to increase tax efficiencies, by reducing multiplicity of taxes and enabling flow of tax credits across the value chain. Thus, not announcing of a date for its introduction is disappointing.
In view of the proposed changes, particularly concerning SEZs and LLP structures, apart from the proposed lower tax rate for dividends from foreign subsidiaries on a gross basis and stricter anti-avoidance measures, it would be imperative for taxpayers to revisit their existing business structures and models ahead of time in preparation for the DTC.
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