The year 2018 witnessed some significant developments for the taxation regime in India with some key changes to the GST and cross-border taxation framework. This update summarises some of the major developments in the past year and gives a brief overview of what can be expected in 2019.
THE YEAR THAT WAS
Over the past year, progress has been made in resolving teething issues in the Goods and Service Tax (GST) laws introduced in 2017. Tax slab rationalisation was a key focus area for the GST Council, and in line with this, many items from the 28% GST slab have been moved to the lower 18% slab. Further, while GST compliances have been simplified, the consensus is that this issue still needs to be addressed, especially for small and medium enterprises. The requirement to collect tax for e-commerce marketplaces and roll out of e-way bill compliances have dampened sectoral outlook.
2018 also witnessed the introduction of long-term capital gains tax on the sale of listed shares and thin-capitalisation rules. There were also several new developments in the concept of business connection and bilateral tax treaties were signed to adapt to the ever-growing forms of business.
MAJOR DEVELOPMENTS IN 2018
1. Direct Tax
(a) Introduction of thin-capitalisation rules
The Finance Act 2018 introduced new restrictions on interest deductibility (thin capitalization rules) in line with the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) project. As per these rules, in case interest paid to a non-resident associated enterprise (AE) is more than INR 10 million in a financial transaction, total interest deduction is capped to 30% of the company's earnings before interest, taxes, depreciation, and amortization, or actual interest paid to AEs, whichever is lower. The cap applies both to interest paid/payable to non-resident AEs or to an unrelated entity where a guarantee/deposit is provided by a non-resident AE. Any interest that exceeds the cap is disallowed as a deduction but may be carried forward for up to eight years and qualify for a future deduction.
(b) India and Hong Kong signed an agreement for avoidance of double taxation (DTAA)
The DTAA between India and Hong Kong came into force on 30 November 2018. The key highlights of this DTAA are:
- A Permanent Establishment (PE) is created if services are provided in India by employees or other personnel of a non-resident entity for more than 183 days within any 12-month period.
- Interest income is to be taxed at the rate of 10% subject to the satisfaction of the beneficial ownership test.
- Fees for technical services and royalties payable to a resident of Hong Kong are to be taxed at the rate of 10% subject to beneficial ownership test.
- Capital gains arising on sale of shares of an Indian company as well as other Indian securities is chargeable to tax in India.
(c) Revised definition of creation of business connection through agents
The Finance Act 2018 broadened the contours of a 'business connection through agency' under the domestic income tax laws. An agent would now include, not only a person who habitually concludes contracts on behalf of the non-resident but also a person who habitually plays a principal role leading to the conclusion of contracts. This amendment brings our domestic law in line with the BEPS Action Plan 7.
(d) Introduction of long-term capital gains on the sale of listed shares
Long term capital gains arising from the transfer of a long-term capital asset, being an equity share in a listed company or a unit of an equity-oriented fund or a unit of a business trust are taxable at the rate of 10% of such capital gains exceeding INR 1 lakh with effect from 1 April 2018. This concessional rate of 10% will be applicable to such long-term capital gains, where securities transaction tax has been paid on both acquisition and transfer of the shares.
(e) Concept of business connection creation through digital presence introduced
To tax e-commerce transactions, in addition to the concept of equalisation levy, India introduced the concept of Significant Economic Presence (SEP). This has been introduced in line with the BEPS Action 1 Report on e-commerce taxation. SEP, under our domestic tax law, means:
- a transaction in respect of any goods, services or property carried out by a non-resident in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction(s) during the previous year exceeds the prescribed amount (yet to be prescribed); or
- systematic and continuous soliciting of business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means.
This provision has been introduced for specifically covering businesses transacted through digital means. The concept of SEP will be applicable whether or not, the agreement for such transactions or activities is entered in India, the non-resident has a place of business in India or the non-resident renders any services in India. In the event of a SEP, that income which is attributable to the transactions or activities referred to above will be taxable in India. However, given that the DTAAs India has with other countries currently do not reflect the creation of PE through digital presence, the beneficial provisions in the DTAA should override the domestic law till the DTAAs also get re-negotiated to reflect the creation of a PE through digital presence.
(f) Chartered accountant certificate not effective for fair market valuation in specific situations
The issue of shares by a closely held company to a resident for a consideration exceeding the fair market value (FMV) of shares, creates deemed income liability in the hands of the company. To calculate FMV of such unquoted equity shares, an FMV report could earlier be obtained from either a chartered accountant or a Category I – Securities and Exchange Board of India (SEBI) merchant banker. However, from 24 May 2018, an FMV report can only be obtained from a Category I – SEBI registered merchant banker.
(g) Specific inclusion of payments related to termination/modification of employment
Earlier due to a difference in judicial opinions, there was some uncertainty relating to the taxation of compensation (or such other payments) due to or received by a person, in connection with the termination of employment or modification of the terms and conditions relating thereto. The Finance Act, 2018 now specifically includes a provision for taxation of such payments as income from other sources.
(h) Revision of monetary thresholds for filing appeals in tax disputes
To eliminate a multitude of pending tax disputes which account for a very small part of tax dues, the Government in 2018, revised tax thresholds for the filing of tax appeals. The threshold in the Supreme Court was increased from INR 25 lakhs to INR 1 crore. For tribunals, it was doubled from INR 10 lakhs to INR 20 lakhs, and for High Courts, it was increased to INR 50 lakhs from INR 20 lakhs.
(i) Planned waiver of tax withholding on the issuance of rupee denominated bonds (RDBs) overseas
In September 2018, the Government announced a waiver of the already concessional 5% interest rate in respect of RDBs issued overseas from 17 September 2018 to 31 March 2019. This press release is however, yet to be notified through an amendment.
(j) Services provided by a secondee employee of a foreign parent to the Indian subsidiary does not result in a PE for the foreign entity
In the case of Samsung Electronics1 (a Korean company), the Income Tax Appellate Tribunal (ITAT) at Delhi, rejected the constitution of a PE through secondment of expatriate employees operating from the premises of Samsung India (the subsidiary). The tribunal by scrutinising the communication between the subsidiary and the holding company noted that the expat employees were discharging duties of the subsidiary company towards the holding company such as stock verification, specificity of the products, the market strategies to be adopted, etc. The tribunal noted that the above activities were in the nature of 'reporting' required in the ordinary discharge of the functions of the subsidiary company towards the holding company and therefore, did not create a PE. Even if the activities amounted to the rendering of services to the subsidiary by the parent, because of the absence of a service PE clause in the unamended version of the India-South Korea DTAA, the tribunal held that there was no question of service PE.
(k) Denial of India-Mauritius DTAA benefits despite of a Tax Residency Certificate (TRC)
The Authority for Advance Rulings (AAR) in the case of AB Mauritius group2 (Mauritius company), rejected the benefits of the Indian-Mauritius DTAA vis-à-vis taxation of capital gains in the hands of the Mauritius company arising from the transfer of shares of an Indian company. The Mauritius company, in this case, had a valid TRC from the Mauritius tax authorities. However, the AAR found the company's modus operandi at the time of the acquisition of shares problematic. It was observed that the Mauritius company was unable to demonstrate that the decision to purchase the Indian company's shares was taken by it acting on its own behalf and that the investment flowed from Mauritius to India. From the facts of the case it was noted that shareholders rights were not exercised by the Mauritian shareholder but by its US holding company instead and that the funds utilized to invest in the shares of the Indian company were sourced from the bank accounts of the US holding company rather than the bank account of the Mauritian shareholder. Therefore, taking into consideration the entire fact pattern, the AAR held that the Indian company's shares did not actually belong to the Mauritius company but to the US-based holding company and accordingly, the India-Mauritius DTAA benefit was denied to the taxpayer.
(l) MasterCard Interface Processor constitutes PE
In the case of MasterCard Asia Pacific Pty Ltd, Singapore3, the AAR ruled that MasterCard Asia had a taxable presence in India on account of its digital footprint. This ruling assumes significance in view of the global trend of taxing 'state-less' income arising from digital transactions and the digital economy. The OECD and EU have both proposed changes in the definition of PE in the tax treaties to deal with this situation. Few countries like the UK have already made changes in their domestic legislation. This ruling has sought to interpret the existing guidelines to give an expansive definition of PE.
(m) Waiver of loan taken for purchase of a capital asset is not taxable as business income
In Commissioner v Mahindra and Mahindra Limited4, the Supreme Court ruled that a waiver of a principal portion of the loan (which was taken for capital account transaction) by a creditor is not taxable in the borrower's hands as business income or a deemed business income. The Court held that the waiver could not be treated as a benefit availed from the cessation of a trading liability because the loan was a capital account liability. Further, the court observed that the waiver could not be treated as a non-monetary taxable benefit under Section 28(iv) of the Income-tax Act, 1961, as the benefit derived by the company on waiver of loan was clearly monetary in nature.
(n) Godaddy's receipts from domain name registration are taxable as royalty
The Delhi ITAT recently held in the Godaddy's receipts case5 that receipts from domain name registration fall under trademark services and hence are taxable as royalty. The tribunal noted that the rendering of services for domain registration tantamount to the rendering of services in connection with the use of an intangible property which is similar to a trademark. This decision has been widely criticised for having taken a view that is contrary to the accepted position in Indian and global tax jurisprudence.
2. Indirect Tax
(a) TDS and TCS provisions introduced under GST
Tax Deducted at Source (TDS) and Tax Collected at Source (TCS) provisions under GST law have become effective from 1 October 2018. The rationale for having the TCS and TDS provisions is to help monitor transactions and to ensure compliance with tax laws.
TCS provisions require e-commerce operators to collect a tax at the rate of 1% on the net value of taxable supplies made through them by third-party sellers, if the consideration for such supplies is collected by the e-commerce operator. The implementation of TCS provisions has caused several compliance problems for e-commerce operators in India.
TDS provisions mandate certain notified government organisations to deduct tax (TDS) at the rate of 2% while making a payment to a supplier for an intra-State supply of goods or services.
(b) E-Way Bill Provisions
The e-way bill provisions in GST law were implemented for inter and intra-State movement of goods. An e-way bill is an electronic document that evidences the movement of goods and contains a unique e-way bill number and other details about the consignment, consignor, and consignee. An e-way bill must be generated if the movement of goods of consignment value more than INR 50,000 is caused by a person registered under GST. These provisions aim to check evasion of GST.
(c) GST on Engineering, Procurement and Construction (EPC) contracts in the renewable energy sector
In EPC contracts, developers generally supply renewable energy generating devices along with associated services like installation, construction, etc. in a single composite contract. While specified renewable energy goods are subject to GST at 5%, depending on the construct of such EPC contracts, these may qualify as 'composite supplies of works contracts', which are subject to a GST rate of 18%. Given this, there was uncertainty regarding the GST rate applicable on EPC contracts for setting up renewable power projects.
To resolve this issue, an explanation has been inserted to the entry for renewable energy goods in the GST Rate Schedule setting out a specific methodology to be adopted for levy of GST.
After adopting this methodology, an effective GST rate of 8.9% (on gross consideration) would apply on EPC contracts for setting up renewable power plants.
(d) Scope of input tax credit (ITC) widened
The law has been amended to exclude activities specified in Schedule III (activities that do not constitute a 'supply' and are thus outside the purview of GST) from the definition of 'exempt supply' for the purposes of reversal of ITC. This allows taxpayers to claim ITC relating to transactions that do not amount to supply by virtue of Schedule III. Earlier, ITC could not be claimed on these transactions.
(e) Interpretation of Exemption Notifications pertaining to Tax Statutes
A five-member bench of the Supreme Court of India in Commissioner of Customs v. Dilip Kumar and Company & Ors.6 has put in place principles for the interpretation of exemption notifications in tax law. The apex court reiterated the principle that an ambiguity in a tax statute would be construed in favour of the taxpayer.
However, it held that an exemption provision must be construed strictly and the onus to prove that a taxpayer falls within the scope of an exemption lies squarely on the taxpayer. Further, in case of an ambiguity in an exemption notification, the benefit of such ambiguity must be interpreted in favour of the tax authorities, and not the taxpayer.
This five-member bench decision has put to rest the ambiguity persisting in tax law due to previous conflicting decisions of the Supreme Court and therefore businesses must rethink their approach to exemption notifications in terms of the principles set out by the Supreme Court in this decision.
(f) Reverse Charge Mechanism diluted
GST law provides for a reverse charge mechanism (RCM) i.e. a registered recipient of goods or services is liable to pay GST if the supplier is unregistered. However, this RCM was put on hold when GST was brought into force in July 2017. After industry representations, RCM on supplies by unregistered suppliers has been diluted and only certain specified classes of registered persons receiving a supply (in respect of specified supplies) are liable to pay GST on RCM basis. This is an industry friendly move and will make compliance with GST easier.
Currently, the government is pro-actively engaged in drafting a new income tax code to bring in a new era of simplification and rationalisation. The government's stated objective is to remove difficulties that have crept in due to numerous successive legislative amendments that have rendered existing statute cumbersome and difficult to understand and apply. Several deductions, exemptions and benefits are also expected to be pruned.
Similarly, as the new GST law plays out and various bottlenecks are identified, we can expect procedural changes to ease compliance and a reduction of tax slabs and rates to provide a fillip to consumption and domestic demand.