India: Budget 2016: What Tax Changes Could Be In Store

Last Updated: 24 February 2016
Article by Himanshu Sinha

The forthcoming Budget will have to balance many competing forces and policy objectives. While the government is eager to push growth, investment and ease of doing business through tax reforms, it also faces the challenge of balancing its books and plugging tax leakages. The 2015 Budget had set the tone for removal of uncertainty in respect of certain high-profile tax issues like indirect transfer of Indian assets, transfer pricing, Minimum Alternative Tax (MAT) on foreign companies – all targeted towards exorcising the ghost of "tax terrorism" unleashed through post-Vodafone retroactive amendment and mindless transfer pricing adjustments.

This initiative is likely to be taken ahead by way of further legislative amendments that will serve to remove the remaining vestiges of uncertainties in the law dealing with indirect transfers. Last year, it was provided that the indirect transfer law would kick-in only if the underlying Indian assets comprised half or more of the global assets. Certain doubts still persist about the computation of value of global and Indian assets in respect of valuation approach and reduction of liabilities. The government is likely to address this issue.

On transfer pricing, the government would be faced with the dilemma of whether to implement the OECD's Base Erosion and Profit Shifting (BEPS) Report, which recommends changes in transfer pricing regime to eliminate aggressive tax planning structures used in shifting profits to low or nil tax countries. Any such change would lead to interpretational and administrative uncertainties that may be perceived by the MNCs as "unfriendly". On the other hand, not following the recommendation may weaken the Indian government's perception of being at the forefront of elimination of BEPS.

As a compromise, the government may choose to soft-pedal this recommendation through rules and administrative guidance rather than legislative amendments, which tend to attract higher level of media attention. Country by Country Reporting (CbCR) is likely to be introduced, which will force large companies to collate and maintain voluminous data regarding their transfer pricing structures around the world. Apart from increasing compliance burden, it would lead to weakening of aggressive transfer pricing arrangements and increased propensity to apply profit split method.

Another BEPS recommendation that is likely to be acted upon in the Budget is the elimination of excessive interest deductions. The government may provide for an EBIDTA (earnings before interest, depreciation, tax and amortisation) threshold to define the maximum permissible interest deductions.

To facilitate more M&As, the government is reportedly thinking of permitting carryover of accumulated losses in mergers regardless of the sector in which the surviving company operates – currently, it is allowed in a limited number of sectors (mostly industrial and infrastructure).

On MAT, the government will have to fulfill its commitment of bringing about a clarification retrospective amendment to exclude foreign funds from MAT on capital gains. The law brought in last year was prospective.

On reduction of tax rates and rationalisation of tax exemptions, the government is likely to take its first steps by bringing down the tax rate while eliminating a few exemptions. One big issue that is being speculated is whether the government might remove the tax exemption available to long-term capital gains arising on sale of listed equities and mutual funds.

While the government is seriously looking at this "unfair" and "pro-rich" sop, the dismal stock market situation may act as a deterrent in this respect. As a middle path, the finance ministry may settle for extending the period of holding of long-term listed equity assets to three years as against the current threshold of one year.

Last year the government set up the RV Easwar Committee to suggest reforms in income tax laws. The committee had submitted its first report suggesting a slew of procedural and minor reforms to improve ease of doing business. Many of these suggestions, which range from rationalising withholding tax thresholds to time-bound processing of refunds, are likely to find their way to the statute book.

While the government's stated vision is to remove tax sops, the startup euphoria may beat the trend and the government is likely to announce several tax benefits for startups and their investors. These may range from capital gains tax exemption on exit to income tax exemption for a few years. Impetus to manufacturing and generation of employment may also buck the trend and see sops for increased investment in these areas.

While the government may want to present a big-bang budget, the reality is tempered with the constraints presented by domestic fiscal and global recessionary pressures.

Originally published in VCCircle

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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