India: Budget 2016 - Key Tax Proposals Relevant For Foreign Investors

Last Updated: 17 March 2016
Article by Trilegal .

An underlying theme of the Indian Budget, 2016 being the promotion of entrepreneurship and foreign investment, the Budget aims to open up avenues for overseas investors and create a conducive business environment through a slew of tax reforms.

In the recent World Bank report on 'Ease of doing business', India succeeded in moving up 12 places from 142 to 130. This is mainly on account of reforms improving the ease of starting a business, easier access to electricity and streamlining construction permits. Budget 2016, which was presented in the Parliament on 29 February 2016, continues to focus on the theme of 'ease of doing business in India', providing certain investment and tax reforms.

Summarised below are some key tax proposals relevant for foreign investors:

1. Reduction and rationalization of tax rates

(a) Corporate tax rate

The corporate tax rate of 30% for resident companies and 40% for non-resident companies has not been changed. However, concessional rates have been prescribed for small and manufacturing companies:

(i) 29% rate has been prescribed for Indian companies whose annual turnover does not exceed INR 50 million (approximately US$ 735,000);

(ii) 25% rate has been prescribed for Indian manufacturing companies formed on or after 1 March, 2016.

(b) Dividend distribution tax (DDT)

It is proposed that resident investors will pay an additional DDT of 10% if their annual dividend income exceeds INR 1 million (approximately US$ 14,700). The proposed amendment will not have any impact on foreign shareholders of an Indian company.

(c) Capital gains

The private equity and venture capital industry will benefit from measures proposed to align taxation of public and private securities. It has been clarified that the tax rate on long term capital gains of non-residents arising from transfer of shares of a private limited company will be 10%. Further, the Budget also proposes to reduce the period of holding securities of an unlisted company for qualifying as long term capital gains from 3 years to 2 years.

2. Exemptions and incentives given to start-ups and investors in start-ups

(a) Start-ups set up from 1 April 2016 up to 31 March 2019 and whose total turnover does not exceed INR 250 million (approximately US$ 3.7 million) are eligible for exemption equal to 100% of their income for 3 out of 5 years. The actual benefit of this exemption is questionable as most start-ups are not profitable in the initial years. Moreover, Minimum Alternate Tax (MAT) will be applicable, if they are profitable. The prevailing rate for MAT is 18.5%.

(b) An exemption from capital gains tax has been provided to investors investing in notified startups, if the long term capital gains proceeds are invested in units of a specified fund, as notified by the Central Government, subject to certain conditions.

3. Applicability of MAT provisions to non-residents

In the current budget, the Government has lived up to its commitment given to the Supreme Court of India that MAT provisions would not apply to foreign companies who do not have a permanent establishment in India.

4. International Financial Services Centre (IFSC)

To facilitate setting up of IFSC, certain tax benefits have been provided:

(a) Exemption from tax on capital gains arising from transactions undertaken in foreign currency on a recognized stock exchange located in IFSC, even where securities transaction tax is not paid in respect of such transactions;

(b) MAT is proposed to be charged at 9% from units located in IFSC.

5. Equalization levy

Under the existing laws, the courts have held that online advertising and digital marketing services rendered from outside India will not be taxed in India in the absence of a permanent establishment as it does not fall under any taxable head.

In order to bring such services to tax, the Government has introduced a new levy titled 'Equalization Levy' at 6% of the amount of consideration for online advertisement / digital media services rendered by a non-resident. The levy will only apply to B2B transactions. However, a constitutional challenge regarding the legislative competence to introduce such a tax cannot be ruled out.

6. Buyback distribution tax

Currently, buyback distribution tax is levied only on certain types of buy-backs (i.e. buy backs done under the erstwhile section 77A of the Companies Act 1956-now section 68 of the Companies Act 2013). Other types of buy-backs continued to be non-taxable. The Budget proposes to plug this tax leakage by applying buyback distribution tax to all kinds of buyback of unlisted shares.

7. Capital gains on rupee denominated bonds

Currency fluctuation on account of appreciation of rupee against a foreign currency will not be taken into account while computing capital gains on redemption of rupee denominated bonds of an Indian company subscribed by a non-resident.

The industry had expected an extension of 5% concessional tax rate on interest pursuant to a previous press release of the tax department dated 29 October 2015. The Finance Bill however has not proposed this amendment.

8. Important steps taken to improve the tax environment and enhance the speed of dispute resolution

(a) Direct Tax Dispute Resolution Scheme 2016

(i) A taxpayer can settle disputes at the first appeal level by paying tax and interest. In cases where disputed tax exceeds INR 1 million or more (approximately US$ 14,700), 25% of minimum penalty will also be payable

(ii) In case of any pending appeal against a penalty order, 25% of minimum penalty will be payable along with tax and interest.

(b) Higher tax withholding for non-residents without PAN

It has been announced that the higher tax withholding of 20% for non-residents without PAN will be rolled back and a foreign tax registration would be sufficient for withholding tax at normal rates.

(c) Reduction of penalty

Previously tax officers had the discretion to levy penalty of 100% to 300% of tax evaded. This discretionary power of the tax officer has now been curtailed by introducing a much lower graded penalty rate (50% to 200% of tax), for different classes of misdemeanors.

(d) One time settlement of "retro-tax" cases

A one-time dispute resolution scheme for ongoing cases under retrospective amendments (such as the Vodafone case) has been provided. Under this scheme the taxpayer will be given the option to drop litigation/ arbitration by paying only the tax component (interest and penalty being waived).

(e) General Anti Avoidance Rules (GAAR)

The government is committed to implement GAAR from 1 April 2017 as stated in the previous budget.

(f) Tax treatment of funds/ business trusts

(i) Exemption from DDT on distribution made by a special purpose vehicle (SPV) to business trust (REITs and INVITs)

Tax efficiency of a REIT model is dependent on the extent of income pass-through status available to the trust. As per the current legislation, dividend received by a business trust from a SPV is subject to DDT at the SPV level but the same is exempt in the hands of the business trust. For this reason, REITs were not considered a tax efficient model.

It is now proposed that the dividend paid by the SPV to the REIT and INVIT will be exempt from DDT where the business trust holds a specified shareholding in the SPV. This step will result in renewed interest in REITs. However, clarity on stamp duty issues and certain aspects of capital gains tax would still be required.

(ii) Encouraging growth of Asset Reconstruction Companies (ARCs) and tax regime of securitization trusts

In order to encourage investment in ARCs, complete pass through of income-tax to securitization trusts including trusts of ARCs has been proposed. The income will be taxed in the hands of the investors instead of the trust. However, the trust will be liable to deduct tax at source.

(iii) Alternative Investment Funds

The existing provisions provide that in respect of any income credited or paid by the investment fund to its investor, TDS will be deducted at 10% by the investment fund. The current framework does not allow non-residents to approach the tax officer for lower or NIL withholding available under relevant Double Taxation Avoidance Agreement (DTAA) for deductions made by the investment fund. The proposed amendment seeks to remedy this and provides that income earned from an investment fund shall be eligible for a lower or nil deduction of TDS as per DTAA.

(g) Tax on patents

For India to emerge as an innovation hub, the Budget has introduced a patent box regime where global income by way of royalty from world wide exploitation of patents developed and registered in India will be taxed at the rate of 10% on a gross basis plus surcharge/cess. The income will not be subject to MAT. Through such proposal the government is seeking to strike a balance between BEPS recommendations and encouraging innovation.

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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