The Union Budget for 2012 to 2013, announced on March 16 2012, proposes a number of far-reaching amendments to both the direct and indirect tax laws in India, some of which will take effect retrospectively. A snapshot of the key proposals is given below.
This budget has seen several crucial proposed amendments to the laws on direct taxes (specifically in relation to international taxation and transfer pricing). The most talked-about change is the retrospective amendment to overcome the recent Supreme Court decision in favour of Vodafone Holdings BV.(1) The court had held that the indirect transfer of shares in an Indian company was not taxable in India, since the Indian revenue authorities did not have the jurisdiction or ability to tax such transactions. By an amendment applicable retroactively from April 1 1962, transfers of, among other things, shares of a company registered or incorporated outside India that substantially derive their value, directly or indirectly, from assets located in India, are now subject to tax. However, it is expected that this amendment, once introduced, will be legally challenged.
In another significant development, a 'royalty' has now, by way of clarification, been defined to include a software licence, irrespective of whether:
- the payer possesses or controls the rights to the software;
- such rights are directly used by the payer; or
- the location of such rights is in India.
This issue has previously been the subject of numerous disputes, with a number of judicial forums reaching the opposite conclusion - namely, that consideration paid for use of a copyrighted article (ie, for canned software) is not a royalty (for further information please see "Court confirms that payment for supply of software is not a royalty"). If a software payment qualifies as a royalty, withholding tax obligations will be triggered for the payer in India. Furthermore, the non-resident payee must register in India and file a return for its income, after obtaining a permanent account number. This amendment also takes effect retrospectively, from June 1 1976, and aims to overcome the divergent views on the taxability of software and withholding in that context.
The budget proposals further include the introduction of a general anti-avoidance rule from April 1 2013, which will apply to an 'impermissible avoidance transaction'. This term is defined as a transaction (or part thereof), the main purpose of which (or one of the main purposes of which) is to obtain a tax benefit, and which:
- creates rights and obligations that are not ordinarily created between independent parties, directly or indirectly;
- results in misuse or abuse of any provision;
- lacks commercial substance; or
- is not for good-faith purposes.
This rule was to be introduced as part of the proposed Direct Taxes Code, but has been brought forward in view of the lack of clarity on heralding in the code.
Such impermissible avoidance transactions may be disregarded, re-characterised or denied treaty benefits. In each case, the onus to prove that a given transaction is not impermissible lies with the assessee. These provisions could potentially be employed to tax even those indirect transfers of shares that are carried out in a jurisdiction with which India has a double taxation avoidance agreement, thus effectively overriding treaty benefits that would otherwise be available.
The budget also includes a proposed extension of the transfer pricing provisions (which require the determination of an arm's-length price for international transactions between associated enterprises) to specified transactions valued at over Rs50 million between resident associated enterprises. For assessees, this will entail:
- applying one of the five prescribed transfer pricing methods to value the transaction; and
- filing the mandatory forms and documentation specific to the transfer pricing provisions.
The central excise duty rate and service tax rate have been increased from 10% to 12%.
Although the timeline on the introduction of the goods and services tax is uncertain, significant changes have been made to the law dealing with taxation of service provision, the most crucial of which is that the 'negative list' approach to taxing services has been brought forward.
For the first time in relation to service tax law, the term 'service' has been defined (and widely) to cover any activity undertaken for consideration, excluding:
- sales of immovable property;
- transactions in money and actionable claims;
- employer-employee services; and
- fees collected by courts and tribunals.
This definition is complemented by a list of 'declared services' that might not otherwise have been considered services, including:
- renting and constructing immovable property;
- granting of rights (eg, IP rights and the right to use software);
- contractual rights and obligations; and
- various composite transactions (involving both goods and service elements).
Under the proposal, all services are to be taxed, except the 17 that are on the negative list. This list includes certain services provided by government authorities and those relating to:
- toll charges;
- betting and gambling;
- residential renting;
- public transport;
- interest from loans; and
The negative list also contains activities which are already subject to other central or state levies, such as manufacture, trading and entertainment/amusement activities. In addition to the negative list, 34 exemptions have been granted, most of which are a continuation of existing exemptions or exclusions.
Simultaneous with the negative list, it has been proposed that rules should be introduced to govern the location of the provision of service. At present, these rules are in the public domain for comments. As service tax is a destination-based consumption tax, the general rule is based on the location of the receiver of service, with an exception for those situations in which the location of the service receiver is unavailable in the ordinary course of business. For specified services, alternative tests have been prescribed, based on the location of the service provider, the place of performance or the location of immovable property in relation to which the service is provided.
For further information on this topic please contact Ranjeet Mahtani at Economic Laws Practice by telephone (+91 22 6636 7000), fax (+91 22 6636 7172) or email ([email protected]).
(1) Vodafone International Holdings BV v UOI (order dated January 20 2012 in Civil Appeal 733/2012, arising out of SLP (C) 26529/2010). For further information please see "Supreme Court issues landmark judgment in Vodafone case".