Budget 2015 introduced in India on 28.02.2015 has made significant changes as far as international taxation are concerned. Major ones include:-
a. Reduction in rate of tax on non-residents for royalties/fees for technical services from 25% to 10%,
b. Offshore funds not to be taxable in India in respect of fund manager located in India.
c. Clarification regarding Indirect transfer provisions
d. Introduction of concept of POEM instead of control and management in determining residency of companies
e. TDS on Interest payments by Indian branches to their foreign banks or its parts.
f. MAT on FIIs – Not applicable in respect of income from capital gains
g. GAAR Deferred to 2017
The Indian budget has changed the landscape with regard to taxability and residential status of companies by introduction of concept of Place of Effective Management and brought within the ambit of Indian taxation the companies whose control and management is not wholly situated in India.
The detailed amendments are as under:
a) Reduction in rate of tax on Income by way of Royalty and Fees for technical services in case of non-residents
The rate of tax on royalty and fees for technical services reduced from 25% to 10% under section 115A of Income Tax Act. A few tax treaties, such as those with Netherlands and Singapore already provided for a tax rate of 10%. This reduction of 10% in the I-T Act will also help suppliers in other countries such as US and UK where the tax rate under the treaty was much higher. However, foreign/non-resident service providers need to obtain PAN in India to avail of 10% rate else without PAN, their income will still be liable for TDS@ 20% instead of 10%.
Note: This is a welcome amendment and would certainly help Indian companies to hire services of foreign/Non-resident service providers at lower cost.
b) Clarity relating to Indirect transfer provisions
The Finance Act, 2012 inserted certain clarificatory amendments in the provisions of section 9. The amendments, inter alia, included insertion of Explanation 5 in section 9(1)(i) w.r.e.f. 1.04.1962 . The Explanation 5 clarified that an asset or capital asset, being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.
Following Exemptions are proposed in the present budget:
i. the exemption shall be available to the transferor of a share of, or interest in, a foreign entity if he along with its associated enterprises, (a) neither holds the right of control or management, b) nor holds voting power or share capital or interest exceeding five per cent. of the total voting power or total share capital, in the foreign company or entity directly holding the Indian assets (direct holding company).
ii. in case the transfer is of shares or interest in a foreign entity which does not hold the Indian assets directly then the exemption shall be available to the transferor if he along with its associated enterprises,-a) neither holds the right of management or control in relation to such company or the entity, b) nor holds any rights in such company which would entitle it to either exercise control or management of the direct holding company or entity or entitle it to voting power exceeding five percent in the direct holding company or entity.
iii. Exemption shall be available in respect of any transfer, subject to certain conditions ,in a scheme of amalgamation or demerger, of a capital asset, being a share of a foreign company which derives, directly or indirectly, its value substantially from the share or shares of an Indian company,
Further, the taxation of gains arising on transfer of a share or interest deriving, directly or indirectly, its value substantially from assets located in India will be on proportional basis.
Note: The amendment shall be applicable prospectively w.e.f. 1.4.2015 and subsequent years. The amendment has the effect of partially nullifying the retrospective amendment made by finance act 2012. The amendment shall definitely repose confidence of foreign investors in Indian growth story and also provide certainity in taxation and promises made by present government. However, this can be used as a great tax planning tool for international corporations having assets in India.
c) Fund Managers in India not to constitute business connection of offshore funds
In the case of off-shore funds, under the existing provisions, the presence of a fund manager in India may create sufficient nexus of the off-shore fund with India and may constitute a business connection in India even though the fund manager may be an independent person.
Similarly, if the fund manager located in India undertakes fund management activity in respect of investments outside India for an off-shore fund, the profits made by the fund from such investments may be liable to tax in India due to the location of fund manager in India and attribution of such profits to the activity of the fund manager undertaken on behalf of the off-shore fund. Therefore, apart from taxation of income received by the fund manager as fees for fund management activity, income of off-shore fund from investments made in countries outside India may also get taxed in India due to such fund management activity undertaken in, and from, India constituting a business connection. Further, presence of the fund manager under certain circumstances may lead to the off shore fund being held to be resident in India on the basis of its control and management being in India.
In order to facilitate location of fund managers of off-shore funds in India a specific regime has been proposed in the Act in line with international best practices with the objective that, subject to fulfillment of certain conditions by the fund and the fund manager,-
i. the tax liability in respect of income arising to the Fund from investment in India would be neutral to the fact as to whether the investment is made directly by the fund or through engagement of Fund manager located in India; and
ii. that income of the fund from the investments outside India would not be taxable in India solely on the basis that the Fund management activity in respect of such investments have been undertaken through a fund manager located in India.
The proposed regime provides that in the case of an eligible investment fund, the fund management activity carried out through an eligible fund manager acting on behalf of such fund shall not constitute business connection in India of the said fund.
Further, it is proposed that an eligible investment fund shall not be said to be resident in India merely because the eligible fund manager undertaking fund management activities on its behalf is located in India.
d) Amendment to the conditions for determining residency status in respect of Companies- Concept of Place of Effective Management (POEM) Introduced
The existing provisions of section 6 of the Act provides for the conditions under which a person can be said to be resident in India for a previous year. In respect of a person being a company the conditions are contained in clause (3) of section 6 of the Act. Under the said clause, a company is said to be resident in India in any previous year, if-
i. it is an Indian company; or
ii. during that year, the control and management of its affairs is situated wholly in India.
Due to the requirement that whole of control and management should be situated in India and that too for whole of the year, the condition has been rendered to be practically inapplicable. A company can easily avoid becoming a resident by simply holding a board meeting outside India. This facilitates creation of shell companies which are incorporated outside but controlled from India. 'Place of effective management' (POEM) is an internationally recognized concept for determination of residence of a company incorporated in a foreign jurisdiction.
It is proposed to amend the provisions of section 6 to provide that a person being a company shall be said to be resident in India in any previous year, if-
i. it is an Indian company; or
ii. its place of effective management, at any time in that year, is in India .
Further, it is proposed to define the place of effective management to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.
The modification in the condition of residence in respect of company by including the concept of effective management would align the provisions of the Act with the Double Taxation Avoidance Agreements (DTAAs) entered into by India with other countries and would also be in line with international standards. It would also be a measure to deal with cases of creation of shell companies outside India but being controlled and managed from India.
These amendments will take effect from 1st April, 2015
Note: The amendment has reversed the position of taxability of companies operating in India. Earlier, the requirement was entire control and management was to be located in india for taxing the company as Indian Resident. However, after the amendment, even at any time of the year, the company’s POEM was located in India, entire income of such shall be taxable in India as Indian Resident.
This will definitely be a highly litigated issue in years to come as the identification of place of effective management leaves much to the discretion of Income tax officers. And would nullify the judicial precedents set by Radha Rani Holdings (P.) Ltd vs. ADIT [2007] 16 SOT 495 (Delhi) and Saraswati Holding Corporation Ltd. Vs. DDIT 16 SOT 535 (Delhi)
e) MAT on FIIs – Not applicable in respect of income from capital gains
The existing provisions contained in section 115JB of the Act provide that in the case of a company, if the tax payable on the total income as computed under the Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 2012, is less than eighteen and one-half percent of its book profit, such book profit shall be deemed to be the total income of the assessee and the tax payable for the relevant previous year shall be eighteen and one-half percent of its book profit. This tax is termed as minimum alternate tax (MAT).
A new clause (iic) is also proposed to be inserted in Explanation 1 to Section 115JB so as to provide that the amount of income from transactions in securities, (other than short term capital gains arising on transactions on which securities transaction tax is not chargeable), accruing or arising to an assessee being a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the Securities and Exchange Board of India Act,1992,if any such amount is credited to the profit and loss account, shall be reduced from the book profit for the purposes of calculation of income-tax payable under the section. Further by inserting a new clause (fb) in Explanation 1, it is proposed that the book profit shall be increased by the amount or amounts of expenditure relatable to the above income.
Note: This is a welcome relief for FIIs and would significantly reduce litigation.
f) Extension of eligible period of concessional tax rate under section 194LD-Interest Income of FIIs
The existing provisions of section 194LD of the Act, provide for lower withholding tax at the rate of 5 percent in case of interest payable at any time on or after the 1st day of June, 2013 but before the 1st day of June, 2015 to FIIs and QFIs on their investments in Government securities and rupee denominated corporate bonds provided that the rate of interest does not exceed the rate notified by the Central Government in this regard.
The limitation date of the eligibility period for benefit of reduced rate of tax available under section 194LC in respect of external commercial borrowings (ECB) has been extended from 30th June, 2015 to 30th June, 2017 by Finance (No.2) Act, 2014.
Accordingly, it is proposed to amend section 194LD to provide that the concessional rate of 5% withholding tax on interest payment under the section will now be available on interest payable upto 30th June, 2017.
g) TDS on Interest payment by Indian branches of Foreign Banks:
It is proposed to amend the Act to provide that, in the case of a non-resident, being a person engaged in the business of banking, any interest payable by the permanent establishment in India of such non-resident to the head office or any permanent establishment or any other part of such non-resident outside India shall be deemed to accrue or arise in India and shall be chargeable to tax in addition to any income attributable to the permanent establishment in India and the permanent establishment in India shall be deemed to be a person separate and independent of the non-resident person of which it is a permanent establishment and the provisions of the Act relating to computation of total income, determination of tax and collection and recovery would apply .
Accordingly, the PE in India shall be obligated to deduct tax at source on any interest payable to either the head office or any other branch or PE, etc. of the non-resident outside India in the case of a non-resident, being a person engaged in the business of banking. Further, non-deduction would result in disallowance of interest claimed as expenditure by the PE and may also attract levy of interest and penalty in accordance with relevant provisions of the Act.
Note: This is an amendment which will impact the current practice of non-taxability of interest paid by Indian branch to foreign parent banking company as set by various judicial precedents including Sumitomo Mitsui Banking Corpn. v. Dy. DIT [2012] 136 ITD 66 (Mum.) (SB) wherein it was held to be non-taxable on the ground of being payment to self/on principles of mutuality. However, there is still no clarity on the taxation of receipt of interest from head office to Indian banking branch. The amendment is applicable only to banking company.
h) TDS return for Foreign Remittance to include all payments whether chargeable to tax or not
The existing provisions of sub-section (6) of section 195 of the Act provide that the person referred to in section 195(1) of the Act shall furnish prescribed information. Section 195(1) of the Act provides that any person responsible for paying any interest (other than interest referred to in sections 194LB or 194LC or 194LD of the Act) or any sum chargeable to tax (not being salary income) to a non-resident, not being a company, or to a foreign company, shall deduct tax at the rates in force.
It is proposed to amend the provisions of section 195 of the Act to provide that the person responsible for paying any sum, whether chargeable to tax or not, to a non-resident, not being a company, or to a foreign company, shall be required to furnish the information of the prescribed sum in such form and manner as may be prescribed.
For ensuring submission of accurate information in respect of remittance to non-resident, it is further proposed to insert a new provision in the Act to provide that in case of non-furnishing of information or furnishing of incorrect information under sub-section (6) of section 195(6) of the Act, a penalty of one lakh rupees shall be levied. These amendments will take effect from 1st June, 2015.
i) Deferment of provisions relating to General Anti Avoidance Rule (“GAAR”)
It is proposed that implementation of GAAR be deferred by two years and GAAR provisions be made applicable to the income of the financial year 2017-18 (Assessment Year 2018-19) and subsequent years by amendment of the Act. Further, investments made up to 31.03.2017 are proposed to be protected from the applicability of GAAR by amendment in the relevant rules in this regard.
SERVICE TAX
j) Change in Service Tax rate:
The Service Tax rate is being increased from 12% plus Education Cesses to 14%. The ‘Education Cess’ and ‘Secondary and Higher Education Cess’ shall be subsumed in the revised rate of Service Tax. Thus, effective increase in Service Tax rate will be from existing rate of 12.36% (inclusive of cesses) to 14%.
The new Service Tax rate shall come into effect from a date to be notified by the Central Government after the enactment of the Finance Bill, 2015.
NOTE: This will impact the cost of import of services as the same are liable for reverse charge mechanism wherein the service recipient is liable to pay service tax on behalf of non-resident in respect of import of services.
k) Enabling the Board to notify rules for giving foreign tax credit
Sub-section (1) of section 91 of the Income-tax Act provides for relief in respect of income-tax on the income which is taxed in India as well as in the country with which there is no Double Taxation Avoidance Agreement (DTAA). It provides that an Indian resident is entitled to a deduction from the Indian income-tax of a sum calculated on such doubly taxed income, at the Indian rate of tax or the rate of tax of said country, whichever is lower. In cases of countries with which India has entered into an agreement for the purposes of avoidance of double taxation under section 90 or section 90A, a relief in respect of income-tax on doubly taxed income is available as per the respective DTAAs.
The Income-tax Act does not provide the manner for granting credit of taxes paid in any country outside India. Accordingly, it is proposed to amend section sub-section (2) of section 295 of the Income-tax Act so as to provide that CBDT may make rules to provide the procedure for granting relief or deduction, as the case may be, of any income-tax paid in any country or specified territory outside India, under section 90, or under section 90A, or under section 91, against the income-tax payable under the Act.
Overall a budget meeting some of the expectations of Non Residents and FIIs. However, the concept of POEM introduced in this budget for determining residential status of companies shall require more detailed guidelines to reduce litigations.
Thanks and best regards
CA Rohit Gupta
B.Com, FCA,LLB,
Certificate In International Taxation(IFA)
Paschim Vihar, Delhi-63
(Author can be reached at ca.guptarohit@gmail.com / 9873832979 for any queries )
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