With the eve of 31 March 2017 marking a cusp of revolutionary change for the Indian tax landscape, the investor community at large braces itself to deal with the consequent changes to investment structures and strategies.
By way of a quick round-up, set out below are few key tax changes that will be / are proposed to be effective from 1 April 2017.
Inbound Investment Structuring
With India’s revised tax treaties with Mauritius, Singapore and Cyprus coming into force, capital gains arising on exit of equity investments made on or after 1 April 2017 from these jurisdictions will be subject to taxation in India. However, given (i) the lower withholding tax rate on interest (7.5% under the Mauritius tax treaty), and (ii) residence based taxation of gains from the sale of instruments other than shares, debt investments through these jurisdictions continue to remain attractive.
With GAAR becoming effective, revenue authorities are now empowered to regulate taxation based on ‘substance’ of a transaction, ignoring its form. Thus, in relation to any ‘tax benefit’ arising on or after 1 April 2017, ‘commercial substance’ will be a crucial consideration for any structure to pass the muster of GAAR.
‘Fair Value’ basis Taxation on ‘Transferor’ of Unquoted Shares
For determination of capital gains taxation on the transferor of unquoted shares, the fair value (determined as per to be prescribed methods) will be deemed to be the minimum sale consideration. Therefore, in addition to the extant provisions which seek to tax the buyer of unquoted shares in certain cases where acquired at a discount to fair value, now transfer of unquoted shares will trigger adverse tax consequences even for the seller.
‘Fair Value’ basis Taxation on Recipient of any property
Currently, only in certain cases including receipt of shares of a closely held company by another closely held company or firm at a discount to fair value, the discount is deemed to be income at the hands of the recipient. This deeming provision will now apply to all persons (i.e. all categories of taxpayers) when they receive any property (as defined, which includes shares). Thus, the said fair value basis taxation is no longer restricted to transactions in shares where both the recipient and target are closely held companies.
On market exit, conditions to tax exemption
Currently, long-term capital gains arising on an on-market transfer of listed equity shares of a company are exempt from tax if Securities Transaction Tax (STT) is paid on such transfers (STT is payable on certain on-market transactions (sale and purchase) and ranges from 0.001% to 0.2% of the value of the transaction.). In order to prevent the misuse of this exemption, the benefit of this provision will be available only where STT has been paid even at the time of acquisition of the shares sought to be transferred.
Concessional withholding tax rate extended to Rupee Denominated Bonds (Masala Bonds)
Concessional withholding tax rate of 5%, as currently applicable to foreign currency bonds, external commercial borrowings and rupee bonds issued to foreign portfolio investors, is being extended to interest payable on Masala Bonds issued before 1 July 2020. This will be retrospectively effective from financial year 2015-16 onwards. Further, an offshore transfer of Masala Bonds, which are issued overseas, from one non-resident to another will not be regarded as a taxable transfer and accordingly, not attract tax in India.
Secondary Adjustments in Transfer Pricing
In order to remove the imbalance between cash account and actual profit of the taxpayer and to align the Indian transfer pricing norms with the guidelines prescribed by the Organisation for Economic Cooperation and Development, secondary adjustments will be required to be made by the taxpayer in certain cases.
Thin Capitalisation Norms
If an Indian company or a permanent establishment of a foreign company in India (collectively, the Borrower) has borrowed money from its non-resident associated enterprise (NR AE) and if such Borrower pays an interest exceeding INR 10 million towards such loan(s), then the ‘excess interest’ (as defined) cost will not be eligible for deduction from the profits of the Borrower. Loans which have been extended to the Borrower by a third-party lender, on the implicit or explicit guarantee of its NR AE, will also be covered under this provision.
The message of the present Government through its slew of policy initiatives is loud and clear – that India is committed to protect its tax base, prevent double non-taxation, and arrest revenue losses to the public exchequer. Given this, strategies for investment and business restructuring will now have to be revisited to provide adequate safeguards for commercial justification.