Tax Hotline: Finance Act, 2015 passed into law: Some creases ironed

We had earlier sent you our hotline on Budget 2015 (India Budget Insights 2015-16) on March 1, 2015 in which we had discussed some of the key changes proposed under the Finance Bill 2015. A copy of the hotline can be found by clicking here.

The Finance Act, 2015 became law on May 14, 2015 after receiving the President’s assent. The Parliament has made certain amendments to the original version of the Finance Bill, 2015 laid in Parliament on February 28, 2015. We have discussed the key amendments and their impact below.

Additionally, the lower house of Parliament has also passed the Constitution (One Hundred and Twenty-Second Amendment) Bill, 2015 for introduction of a single Goods and Services Tax (“GST”) subsuming most indirect taxes. GST is expected to rationalize the indirect tax regime and reduce the cascading effect of multiple taxes (including customs duty, service tax etc.) and also reduce administrative costs of compliance in relation to multiple taxes. The government expects to roll out GST with effect from April 1, 2016. As a pre-cursor to the introduction of GST, the Finance Act, 2015 increases service tax from 12.36% currently to 14% (from such date to be notified separately). This could further increase to 16% with the notification of the Swachh Bharat Cess.

Key amendments made to the Finance Bill, 2015 (as originally introduced) are as follows:

1. PROSPECTIVE MAT EXEMPTION NET WIDENED

Budget 2015 had introduced a prospective exemption to FPIs from MAT in relation to capital gains from transfer of securities (except capital gains from transfer of unlisted securities held for less than 3 years and listed securities held for less than one year and transferred off the floor of the stock exchange). This exemption has now been extended to all foreign companies and to the following streams of income: (i) all capital gains from transfer of marketable securities, (ii) interest, royalty and fees for technical services accruing to a foreign company.

Owing to criticisms on the limited applicability of MAT exemptions, the exemptions have now been extended to all foreign companies rather than only Foreign Portfolio Investors (FPIs). This is a welcome move especially since it is in line with the view that MAT cannot apply to foreign companies that do not prepare account in accordance with Indian company laws i.e. foreign companies not having a place of business in India.

However, the amendment continues to be prospective in nature (as was the case under the Finance Bill, 2015 as originally introduced) and will not impact or benefit FPIs that have been receiving tax notices in the past couple of months on the basis of applicability of MAT to past gains on investments.

The matter is currently before the Supreme Court in the case of Castleton, which was a case of a Foreign Direct Investment from Mauritius. Additionally, there are two other matters before the Bombay High Court which have challenged the application of the MAT provisions to FPIs. These matters are likely to get decided in the later part of this year, which may bring in the much needed certainty on this issue.

A number of FPIs make investments into India through jurisdictions such as Singapore and Mauritius. In their current form, the wordings of the MAT provisions are ambiguous in so far as applicability in case of treaty relief is concerned. In this context, it may be noted that the Revenue Secretary has made a statement that where treaty benefits are available on capital gains, such benefit will continue to apply. The Central Board of Direct Taxes has subsequently come out with an instruction¹ to the field officers to expeditiously decide matters where treaty benefit is available. While the instruction doesn’t explicitly provide that treaty benefit should be provided, when read with the statements of the Revenue Secretary, the approach that will probably be taken by the tax authorities is be to allow treaty relief.

While the statement made by the Revenue Secretary is not legally binding on the Government, it is hoped that the Government will now not take a different stance after having made their view public.

2. MAT EXEMPTION FOR REITS

The Finance Act, 2014 introduced a new tax regime for Real Estate Investment Trusts and Infrastructure Investment Trusts (REITs) which however proved inadequate and failed to garner investor interest in REITs. The Finance Bill, 2015 (as originally introduced) sought to provide additional clarity in this respect. It introduced exemption from capital gains arising to the sponsor from transfer of real property directly into the trust. As per original bill, the sponsor was sought to be been given capital gains exemptions both on transfer of SPV shares to the trust and on later sale of trust units.

Despite the capital gains exemption to sponsors of a REIT, there was no exemption on MAT, a levy which could entail and additional tax burden at 18.5% of the book profits of the sponsor. The Finance Act, 2015 goes on to address this issue and provides relief to sponsors from MAT in respect of gains arising on transfer of a capital asset, being share of a special purpose vehicle to a business trust in exchange of units allotted by that trust.

This comes as a welcome move to the REIT industry, especially since no REIT has yet been set up in India yet, despite the regulations coming into place over a year ago. A strong reason for this was lack of clarity on taxation of REITs. However, the issue that still remains outstanding is that the sale of units by sponsor is taxable, unlike in cases of sale of units by non-sponsor which have been provided with a preferential capital gains tax regime.

3. CHANGE IN RESIDENCE TEST FOR FOREIGN CORPORATES RATIONALISED

Criteria for determination of residence of offshore companies become important in various circumstances involving majority ownership by Indian residents, including outbound investment structures by Indian business families and personal wealth/carried interest structures such as personal holding companies.

Till financial year 2014-15, an offshore company has been treated as “non-resident” in India unless wholly controlled and managed from India. The consequence is that the income of such offshore company was not taxable in India, unless distributed to an Indian resident shareholder. The Finance Bill, 2015 (as originally introduced) proposed to introduce the subjective test of place of effective management (“POEM”), and considered a foreign company resident in India if its POEM is in India “at any time” in the relevant financial year. It was feared that this proposal would cover one-off instances, like a board meeting, or negotiation of a contract with a client, etc., being conducted in India. The Finance Act, 2015 removed the words “at any time” to allay such fears. Therefore, POEM is to be applied taking the relevant financial year as a whole into consideration.

This change is an important step in bringing the corporate residence test in line with global standards.

However, compared to the earlier law, this test introduces a more subjective threshold as POEM has been defined 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”. This is the same interpretation adopted in the commentary to the OECD Model Convention. However, in determining what factors carry more weightage, it is not clear whether the Indian tax authorities would give weightage to existing jurisprudence globally.

As per the earlier law, even in situations where an offshore company is 100% owned by Indian residents and has majority Indian directors, it has been held that there should be no residence in India if board meetings are held outside India. As per the Finance Act, 2015, even after considering the amendments made by Parliament, concerns continue as to whether such a company could be construed to be an Indian company by virtue of the fact that majority control is exercised by Indian resident persons. Similar concerns also apply where some portion of shareholding of the offshore company is held by non-Indian investors and Indian promoters exercise significant ownership and control.

In a vibrant economy with Indian residents, families and companies looking to explore different opportunities globally, it would be important for the government to provide some guidance / FAQs on the applicability of the POEM threshold, which is a subjective test.

4. CHANGES IN DISCLOSURE REQUIREMENTS FOR FOREIGN ASSETS

In 2012, disclosure requirements were introduced for resident individuals (except those qualifying as not ordinarily resident) with respect to assets held outside India. The Finance Act, 2015 has modified these requirements. It may be noted that the Finance Bill, 2015 (as originally introduced) did not contemplate any such changes.

Currently, disclosure requirements are applicable in relation to asset held outside India (including financial interest in any entity) and in relation to signing authority in any account located outside India. In light of the description in the tax return forms and instructions issued to the forms, there has been some ambiguity in relation to scope of the term ‘financial interest’, particularly, in the context of indirectly held assets and in the context of beneficiaries of offshore discretionary trusts. For example, where an individual held 5% shares in an offshore company, it is not completely clear as to whether the assets of the company are also required to be disclosed (though it is a significant compliance burden for portfolio investors).

Also, in case of individuals named as beneficiaries to offshore discretionary trusts, such beneficiaries do not hold interest to any specific portion of income or corpus of the trust. Therefore, it becomes difficult for such individuals to quantify the extent of financial interest they hold in such trusts.

The Finance Act, 2015 passed by Parliament modifies the disclosure requirement such that all resident individuals who are either beneficial owners or beneficiaries of foreign assets (including financial interest in any entity) or who have signing authority in any account outside India are covered. In India, the concept of a ‘beneficial owner’ is not recognized. The term “beneficial owner” has been defined to mean “an individual who has provided, directly or indirectly, consideration for the asset for the immediate or future benefit, direct or indirect, of himself or any other person.” The term “beneficiary” has been defined to mean “an individual who derives benefit from the asset during the previous year and the consideration for such asset has been provided by any person other than such beneficiary”.

It may be noted that revised tax return forms and instructions were recently issued by the government (prior to the Finance Act, 2015 being passed into law). Amendments similar to those introduced by the Finance Act, 2015 had been made in the instructions. However, the ambiguity in relation to the scope of the term ‘financial interest’ is yet to be resolved. In light of negative feedback from various stakeholders against the revised forms, the Finance Minister, while presenting the amendments to the Finance Bill, 2015, stated that the tax return forms would be simplified. However, whether the lack of clarity in relation to the scope of ‘financial interest’ will be addressed remains to be seen.

With increase in the number of Indian families having one or more members residing outside India, there has been an increase in the number of offshore trusts settled by such members outside India during their stay abroad. In light of various cross-border considerations, there are several legitimate non-tax considerations for setting up such trusts. While many individuals are open to disclosing their assets offshore, there is also concern in relation to unwarranted scrutiny and harassment in light of the manner in which offshore assets are currently being scrutinized by the Indian government (reflecting an inherent bias that offshore assets are considered to be acquired using income from illegitimate sources). Given such context, it is expected that the government clarifies the scope of the disclosure requirements in the amended tax return forms and introduces proper checks and balances to ensure that the tax authorities do not abuse their discretionary powers arbitrarily.

5. CLARITY ON REDEMPTION OF GDRS

The Depository Receipts Scheme, 2014 allows issuance of GDRs against a wide range of permissible underlying securities (including debt and mutual fund units), by listed and unlisted Indian companies alike. In line with this, Budget 2015 introduced a concessional tax rate of 10% on long term capital gains on the transfer of GDRs to residents and exemption from capital gains tax on transfer of GDRs from one non-resident to another where the underlying securities. However, this concessional rate was not available in cases where the underlying securities are ordinary shares of unlisted companies. It was expected that these concessional rates were extended to all permissible underlying instruments.

Although the concessional rates were not extended to all categories of underlying securities, the Finance Act, 2015 provides greater clarity on treatment of redemption of GDRs.

Further, calculation of holding period for shares issued to a non-resident on redemption of GDRs would begin from the date on which a request for redemption was made. Further, the cost of acquisition of the share or shares acquired by a non-resident on redemption of GDRs shall be the price of the shares as prevailing on any recognized stock exchange on the date on which a request for such redemption was made.

ANALYSIS

The government has taken some important steps to rationalize existing provisions, to clarify ambiguities and to bring Indian law in line with global standards. However, these attempts appear to be piecemeal in nature, as several other issues have been left unresolved. Some missed opportunities include addressing issues such as levy of dividend distribution tax and buyback taxation as a tax on the company as against a tax on the shareholder, notices in relation to levy of MAT on past income of foreign companies, absence of clarity on ‘financial interest’ for the purposes of disclosure of foreign assets, taxation of share premium paid by angel investors, need for reducing high-pitched transfer pricing assessments, need for measures for improving accountability of tax authorities deciding tax assessments, etc.

Further, several changes appear to have been taken in a haste without analyzing the implications comprehensively. As a result, many changes do not achieve the intended objective, for example, permanent establishment relief for fund managers, relief in relation to taxation of REITs (Real Estate Investment Trusts). Also, in case of taxation of indirect transfer, the amendments introduced are quite broad in nature (including transfer of shares in listed companies), does not address issues relating to step-up in basis for future transfer of assets, does not provide clarity on taxation of transactions undertaken between 2012 and 2015, etc. For more details, see our hotline on Budget 2015 by clicking here.

On the whole, the constant emphasis on need for clarity in tax laws has been seen as a strong commitment from the government. However, as the gaps between the promises made by the government and the concrete steps taken towards implementing them appears to be increasing by the day, the government seems to be falling prey to its own strengths and investors, who appeared to be buoyed by the new government initially appears to be getting more cautious and careful in exploring opportunities in India.

¹ F.No. 500/36/2015-FTD.I dated April 24, 2015