India: SKP Tax Trends (October - December 2017)

Last Updated: 16 January 2018
Article by SKP  

We are happy to present the latest edition of Tax Trends, SKP's Direct Tax Newsletter. This edition covers the period from October to December 2017.

The United States (US) tax reforms are creating ripples around the world with many countries evaluating their responses to the effect of the US tax reforms. The most notable feature of the tax reforms has been a massive reduction in the corporate tax rate from existing 35% to 21% and certain measures to bring back business operations to the US. Under Spotlight, we discuss some of the key US tax reform proposals and their impact on the India-US trade.

The Union Budget 2018 will be announced on 1 February 2018 and could very well bring in a slew of economic reforms. Expectations from the Union Budgets of the present government have always been high, and this time, the expectations are even higher. This budget will be presented against the backdrop of the effects of economic reforms such as the Goods and Services Tax (GST), demonetisation of high-denomination notes, rural agrarian challenges and recent political developments. The individual taxpayer also expects reforms to bring significant tax savings, since there is a perception that the government has done precious little for the individual taxpayer in the last few years.

The Budget could also reflect the government's reaction to global developments such as the US tax reforms, rising popularity of crypto-currencies, developments around the Base Erosion and Profit Shifting (BEPS) project and the increasing need to effectively tax the Digital Economy.

Cryptocurrencies continue to make rapid strides in popularity in India and concerns are being raised on their effect on the economy. A question to this effect was asked during the Question Hour in the Rajya Sabha (Upper House). At present, there are no specific regulations dealing with investments in cryptocurrencies. The Reserve Bank of India (RBI), however, has issued multiple warnings to investors stating that cryptocurrencies are unregulated and investors could face high risks. The Finance Ministry sought to compare cryptocurrencies to Ponzi schemes. However, the government has stopped short of banning investments in cryptocurrencies.

On the tax litigation front, the government has moved forward with its initiative of electronic revenue audits (scrutiny assessments) and has issued certain details about how the e-assessment regime could operate. It is expected that certain enabling changes will be made to the tax law, in the upcoming Budget.

SPOTLIGHT

US tax reforms and their impact on India

In what could be one of the quickest tax reform legislation of recent times, the United States (US) tax reforms have been enacted into a Law. Given the radical nature of the reform proposals, there was a lot of skepticism about whether the reforms would be passed at all. The budget resolution provided that the tax loss due to the tax reforms bill cannot exceed USD 1.5 trillion over a 10-year period. After much discussion, deliberation, negotiation and even ridicule, the US congress has passed the tax reforms Bill, which will be effective from 1 January 2018.

Such radical changes to the US tax policies will certainly create ripples around the globe. Some of the key reform measures, in principle, and their likely impact on the India-US trade are discussed below.

Reduction in the Corporate Tax Rate

The headline corporate tax rate has been reduced from existing 35% to 21%, which is a massive reduction of 14%. The reduced rate will take effect from tax years beginning from 1 January 2018. For instance, if the tax year starts from 1 April 2018, the rate of 21% shall apply from 1 April onwards. The taxable income earned during January to March 2018 will continue to be taxed at the existing rate of 35%.

The US government expects that the loss of tax revenue will be made good by increasing the tax base as many businesses are expected to move their operations to the US.

Abolishing AMT

The Alternate Minimum Tax (AMT) (which is similar in concept to the Minimum Alternate Tax (MAT) levied by India) has been abolished. Taxpayers with existing AMT credits can carry them forward for the next four years (up to 2021) and may be able to claim a refund of 50% of the unutilised AMT credits, subject to certain conditions. For tax years 2021 and 2022, the refund could go up to 100% of the unutilised AMT credit.

Deemed Profit Repatriation Tax

Previously, US-based corporations were taxed on their worldwide income including income earned by their overseas subsidiaries, unless the overseas income was permanently kept outside of the US. This prompted many taxpayers to retain their profits overseas.

As a measure to curb such tendencies and to create a level playing field, the US now imposes a one-time deemed profit repatriation tax on all profits retained overseas. Simply put, US-based taxpayers will have to pay tax in the US on their overseas profits, even if these profits are not actually repatriated to the US.

This tax will be charged at 8% on illiquid assets and 15.5% percent on liquid assets, and a partial underlying tax credit would be available to the taxpayers. Furthermore, the taxpayer will have the option of deferring the payment of tax over a period of eight years.

As an anti-abuse measure, the base for calculating the deemed profit repatriation tax will be the earnings and profit amount as on 2 November 2017 or as on 31 December 2017, whichever is higher. Thus, any reductions in the earnings and profits (or conversion from liquid assets to illiquid assets) between 2 November 2017 and 31 December 2017, will not affect the tax liability.

Migration to a Territorial Tax System

Once the one-time deemed profit repatriation tax is levied, the US will have a territorial tax system where profits earned by specified 10%- owned overseas entities will not be taxed in the US. Thus, all dividends repatriation by the US subsidiaries back to the US would be effectively tax exempt. These measures will be applicable on all 'active' business earnings and dividends earned after 2017. One would , of course, have to look at what constitutes active' business income.

Anti-Abuse Tax on Overseas Payments

This was one of the most widely debated reform measures. The US will now impose a 10% Base Erosion and Anti-Abuse Tax (BEAT) on certain payments, including interest, to overseas related parties if the payments exceed 50% of the taxable income of the US entity.

The BEAT will apply to companies where the group turnover exceeds USD 500 million, calculated as an average of the last three years. It also proposes a threshold based on the ratio of deductible payments to the taxable income of the US entity (Base Erosion percentage). Most importantly, BEAT does not apply to payments for the cost of goods sold (other than inverted corporations).

BEAT's application in practice is expected to be challenging. The BEAT provisions are contained in more than 20 pages and there are multi-step formulae to calculate BEAT.

Limiting Interest Deduction

The tax reforms provide that the business interest deduction shall be limited to 30% of the operating Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) (derived through certain specified adjustments). Post 2021, it appears that the deduction will be calculated based on Earnings Before Interest and Taxes (EBIT). Any excess (disallowed) interest can be indefinitely carried forward to the subsequent years. These provisions shall apply only where the gross receipts of a taxpayer exceed USD 25 million, calculated as an average of the past three years.

These provisions would equally apply to the existing debt in the capital structure of a US entity, i.e., there is no grandfathering provided for existing debt investments. Furthermore, these provisions do not take into account the US entity's contribution to the net interest of the group as well as its contribution to the worldwide EBITDA, similar to Section 94B of the Indian Income Tax Act, 1961.

Other changes

Apart from the above, the tax reforms include significant changes by way of a favourable tax regime on foreign-derived intangibles income, restrictions on set-off of Net Operating Losses (NOL) to 80% of the taxable income with indefinite carry-forward but no carry-back, immediate write-off of certain capital expenditure, etc.

Overall, the US tax reform proposals run over 1,000 pages and provide for complex structural modifications to the existing US tax laws. Taxpayers need to evaluate the impact of the tax reforms on a holistic basis and should refrain from taking a myopic view of a particular reform measure. The impact of the reforms could vary from country to country and taxpayer to taxpayer. The impact also depends on how the world reacts to the US tax reforms and how the interplay of different macro-economics forces plays out in the near future.

LEGAL UPDATES

Limitation of Benefit clause cannot be applied where the benefit provided in the India -UAE DTAA is also available in the India-Germany DTAA

Martrade Gulf Logistics FZCOUAE [TS-575-ITAT-2017] (Rajkot Tribunal)

The taxpayer, a company incorporated in the United Arab Emirates (UAE), was engaged in the shipping business and derived income by operating ships in India. The entire share capital of the taxpayer was held by German entities. The taxpayer claimed the benefit of Article 8 of the India-UAE DTAA (Shipping Income) and contended that the income earned from India was not taxable in India.

The tax officer held that the taxpayer cannot be treated as a resident of UAE because its directors and shareholders were not residents of the UAE and its Annual General Meetings (AGM) were held outside the UAE. The tax officer also invoked the Limitation of Benefit (LoB) clause provided in Article 29 of the India- UAE DTAA and denied the benefit of DTAA on the grounds that the taxpayer was not a resident of the UAE.

The Tax Tribunal observed that the residency of shareholders, residency of directors and the place of AGM is not a relevant factor to determine the residency of the taxpayer. Given that board meetings were held in UAE wherein important decisions were taken and also the senior staff, including the Managing Director, were residents of the UAE, the taxpayer's Place of Effective Management (POEM) was in the UAE. Furthermore, with respect to the LoB clause under Article 29 of the India- UAE DTAA, the Tax Tribunal observed that if shipping business was carried out directly by the German entities, similar exemption of taxability in India was available in India-Germany DTAA as well. Accordingly, whether the company was a resident of UAE or Germany would not have made any material difference and the shipping income could not be taxed in India.

Cost to cost reimbursements for services provided by third parties cannot be brought to tax in the hand of the person making payment for the service and receiving reimbursement for the same

The Timken Company [TS-569-ITAT- 2017 (Kolkata Tribunal)

The taxpayer, a tax resident of the US, was providing services like management services, information resources, communication services, etc. to Timken India Ltd (TIL). The taxpayer incurred certain expenses on behalf of TIL for services provided by third parties and recharged the same to TIL on an actual cost basis. The taxpayer contended that it has acted as a conduit and derived no income from such reimbursement, hence the same is not taxable in India.

The tax officer observed that the expenses reimbursed include legal expenses, inspection and survey expense, airfare, local conveyance, etc. incurred on behalf of the employees of TIL to attend workshops, seminars, training courses. The tax officer held that legal expense and inspection expense are technical services while the training made available technical know-how, experience, skill, etc. and therefore, is taxable as fees for technical services in India in the hands of the taxpayer.

The Tax Tribunal held that services were provided by third parties and the taxpayer is not the ultimate beneficiary for such receipt. Furthermore, the taxpayer has received the amount on actual cost basis and therefore, such receipt would not be taxable in the hands of the taxpayer. The Tribunal also held that at best, such income could be taxed in the hands of the third party service provider and not the taxpayer.

Guarantee fees received by non-resident with respect to loan availed by entities in India shall be taxable as other income under Article 23 of India-UK DTAA

Johnson Matthey Public Ltd Company [TS-578-ITAT-2017] (Delhi Tribunal)

The taxpayer, a resident of the UK, was the ultimate parent company of two companies in India. The taxpayer provided guarantees to two foreign banks outside India to support credit facilities extended to the Indian entities by banks in India. The taxpayer received guarantee fees from the Indian entities and offered the same to tax as interest under Article 12 of India-UK DTAA and applied the tax rate of 15%.

The tax officer contended that the guarantee fees received by the taxpayer should be taxable as other income under Article 23 of the India-UK DTAA at the rate of 40%.

The Tax Tribunal held that the guarantee fees accrued to the taxpayer as result of the guarantee agreement and not due to the loan agreement entered by the Indian entities with Indian banks. Accordingly, the income would be taxable as other income as per Article 23 of the India-UK DTAA.

Payments for online advertisement space to be considered as royalty

Google India Private Limited [TS-468- ITAT-2017] (Bangalore Tribunal)

The taxpayer was an Indian company which entered into a non-exclusive marketing and distributor agreement for the purchase of online advertising space on Google's AdWords Program (GAP). GAP is an online advertising service developed by Google, where advertisers pay to display brief advertising copy, product listings and video content within the Google ad network to web users. The taxpayer contended that payments made to Google Ireland (GIL) was towards the purchase of ad space and same being business income, in the absence of the receiver's Permanent Establishment (PE) in India, would not be taxable in India and therefore no taxes were withheld by the taxpayer.

The tax officer held that payments made by taxpayer to GIL is for the license of GAP and therefore taxable as royalty as per the Income Tax Act, 1961 (Act) as well as India-Ireland DTAA.

The Tax Tribunal observed that the agreement was not merely an agreement to sell ad space, but rather it was agreement to provide services to facilitate display and publication of advertisement to customers. For providing such services, the taxpayer had access to various tools and information which is the intellectual property of GIL. GIL had also granted the taxpayer the right access to confidential information and intellectual property rights. Accordingly, tribunal held the payment made by taxpayer to GIL as royalty.

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