Tax Hotline: India Cracks Down on Black Money

• Following a Budgetary promise, the Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015 is introduced to tax foreign undisclosed income and assets of tax residents of India.
• Non-disclosure of foreign income and assets is chargeable to 30% tax with a penalty of three times the tax due and rigorous imprisonment of between 3-10 years.
• A one-time short compliance window has been provided for taxpayers to come clean. Tax and penalty are payable but there is immunity from prosecution.

Buoyed with the recent success in obtaining information from Swiss authorities on undisclosed accounts of Indians in Swiss banks, the Finance Minister had proposed in the Budget (announced on 28 February) that he would introduce a Bill in the ongoing Parliamentary session to deal solely with offshore black money. This led to the ‘The Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015’ (“UFIA Bill”), whose key features are the subject of this Hotline.

The UFIA Bill is to take effect from 1 April 2016, i.e. from the financial year 1 April 2015- 31 March 2016. It has been conceptualized as a separate tax regime, independent of the ITA but to operate alongside with it in their respective spheres. Key features are examined below:

Who does the UFIA Bill apply to?

This Bill applies to a person: (i) who is a tax resident of India as per the tests of the Income Tax Act, 1961 (“ITA”); (ii) who is not a person who is a ‘resident but not ordinarily resident’¹; and (iii) by whom tax is payable under the UFIA Bill on undisclosed foreign income and assets or any other sum of money.

The term ‘person’ is not defined in the UFIA Bill so its definition under the ITA must be adopted. As regards individuals, the ITA has a day-count test of physical stay in India. For companies, the test is whether the company is incorporated in India or is wholly controlled and managed within India. The Finance Bill 2015 has proposed to replace this with the standard of ‘place of effective management’ (POEM). A foreign company will be considered tax resident in India if its POEM is in India at any time in the relevant financial year. 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”. There is still not enough clarity on what would constitute the place where “key management decisions are in substance made” i.e. whether the residence of directors will be looked at, location of board meetings or other criteria such as expansive veto rights by Indian resident shareholders. If POEM does become the test for corporate residence in the ITA going forward, the impact of the UFIA Bill may have a wider scope than intended.

The UFIA Bill imposes personal liability on manager (including a managing director) of a company to pay any amount due under the UFIA if the amount is not recoverable from the company. Partners in a partnership, members of an Association of Persons (AoPs) or of a Body of Individuals (BoI) have been made liable to pay any amount due under the UFIA Bill along with the partnership, AoP or BoI.

The UFIA Bill imposes liability for abetting or inducing another to willfully attempt to evade tax or to make false statements/declarations in relation to foreign income and assets. The objective of this provision is to target professional advisors such as private banks, accountants, lawyers and other consultants whose actions may potentially be covered under ‘abetment or inducement’. This move is a good means to make the UFIA Bill comprehensive in its scope. That said, it is bound to cause concern among practitioners as there is no clear guidance on what precautions or due diligence will be sufficient to indicate practitioners acted within their rights or that they did not beach their code of conduct. Imposition of such liability on professional advisors and intermediaries may adversely affect onboarding of Indian clients while practitioners may apprehend the risk of undue harassment at the hands of Revenue officials.

What income or assets does the UFIA Bill cover?

The UFIA Bill covers undisclosed foreign income and assets (“UFIA”) which means the total amount of undisclosed income from a source located outside India (“UFI”) and the value of an undisclosed asset located outside India (“UFA”).

UFI encompasses foreign income: (i) which has not been disclosed under applicable tax returns under the ITA or (ii) for which a tax return should have been filed under the ITA but was not filed. UFA refers to an asset (including financial interest in any entity) located outside India, held by a taxpayer in his name or in respect of which he is a beneficial owner and he has no explanation about the source of investment in such asset or his explanation is not to the satisfaction of the Revenue.

However, UFAs being one or more bank accounts having a maximum aggregate balance (at any time during a previous year) of INR500,000 (INR 5 lakh) will be excluded from the purview of this Bill.

Unfortunately, the UFIA Bill does not explain what ‘financial interest in any entity’ means. The ITA has made it mandatory on residents to disclose such interest in applicable tax returns. Neither the ITA nor the Income Tax Rules define this phrase. Guidance may be taken from the Instructions accompanying the tax returns. The Instructions provide an illustrative (and not exhaustive) list². Of this list, the entry on beneficial interest in a trust requires more clarity. Neither the ITA nor the UFIA Bill explain the nature and extent of disclosure liability on beneficiaries of foreign discretionary trusts. In many instances, individuals are not aware they have been named beneficiaries especially in the case of testamentary trusts. Imposing a mandatory disclosure requirement in such cases will end up causing hardship. The Bill does not specify whether mere knowledge that one is eligible to be a beneficiary of a trust is sufficient. There is also no clarity on reporting in respect of those with reversionary interests or remainder interests in a trust and at what stage should knowledge of their interest be attributed to them. Until official guidance is issued on these pressing matters, it may cause unintended confusion among taxpayers and defeat the objective of this clean-up exercise.

What are the consequences of having UFIA?

The total UFIA of an assessee will be chargeable to a flat 30% without allowing any exemption, deduction or set off of carried forward losses regardless of whether those were allowable under the ITA. In addition, a penalty of a sum three times the tax on the UFIA is also payable.

To calculate the value of UFA, income already assessed under the ITA shall be deducted from the value of the UFA if the Revenue is provided satisfactory evidence of such prior assessment. A particular calculation method has been prescribed where the UFA is immoveable property. If the UFA is located outside India, its value shall be brought to tax in the relevant previous year in which such asset comes to the notice of the Revenue.

A practical concern that may come up is whether declarants under the compliance scheme (see further below) or offenders have the ability and resources to pay the large sums involved, especially since tax and penalty is to be calculated on the current price of the asset and not the price at which it was purchased.

The other interest, penalty and imprisonment consequences are listed below:

Is there a time limit for completion of assessment?

Yes, a time limit for completion of assessment and re-assessment has been provided under the UFIA Bill. Once the Revenue has issued a notice to a person for providing information, an order of assessment or re-assessment cannot be made after the expiry of two years from the end of the financial year in which the notice was issued. However, this period shall not include the time taken to receive information under the exchange of information process provided under a tax treaty or exchange of information agreement.

Who has the burden of proof of culpability under the UFIA Bill?

The UFIA Bill presumes that the accused has the required culpable mental state for an offence under the Act. That is, it is presumed that the accused had the intention, motive or knowledge of a fact or belief in, or reason to believe, a fact to commit an act considered an offence under the UFIA Bill. The onus to prove non-culpability beyond reasonable doubt is shifted to the accused. Considering that penal consequences are being imposed, it is a cause of concern that legislators have sought to shift the burden of proof on to the accused.

Is there an amnesty scheme under the UFIA Bill?

There is no amnesty scheme under the UFIA Bill because the Supreme Court’s verdict in the late 1990s had barred the Government from offering amnesty schemes owing to public interest litigation³ over the Voluntary Disclosure Income Scheme, 1997. Instead, the UFIA Bill offers a one-time disclosure & compliance scheme. It is not an amnesty scheme as there is no immunity from penalty, although there is immunity from prosecution.

The UFIA Bill offers a one-time compliance window for a limited duration of time (period yet to be notified by the Government) for persons to declare their UFAs and pay tax on it (30% of the UFA) together with penalty (equal to the tax). The tax is to be calculated on the value of the UFA (see above as to calculation) as on the date of commencement of the enacted legislation. However, the UFIA Bill also excludes certain persons from availing of this compliance benefit. For instance, where a UFA has been acquired with income chargeable under the ITA and about which the Government has already received information under a tax treaty or in relation to prosecution of an offence under the Prevention of Corruption Act, 1988. It also remains to be seen how the Revenue deals with a declarant under the compliance scheme whose declaration is not accepted, to what extent is such declarant protected from prosecution under the UFIA Bill or other legislations once the Revenue have the necessary information with them.

UFAs that are declared are also exempt from Wealth Tax. Declarants will not be prosecuted under the Bill.

Tax and penalty must be paid (both being non-refundable) and proof of payment must be submitted within the period notified for this purpose. If these steps are done, undisclosed investment in the UFA shall not be included in the total income for the purposes of the ITA. If these steps are not done or if the declaration has a misrepresentation or suppresses facts, the declaration will be considered void.

Declarants are not entitled to make any other declaration under the Bill. If made, it will be considered void. Declarants are also not entitled to reopen any assessment or reassessment or claim any relief in any proceeding in relation to the assessment or reassessment. The contents of the declaration cannot be used in evidence for imposing penalties under any other law or for prosecution under certain legislations specified, for e.g. the ITA, Companies Act, Foreign Exchange Management Act, 1999.

How do the ITA and UFIA intersect?

1. Terms that have been used in the UFIA Bill but not defined in the Bill shall, if defined under the ITA, adopt the ITA definition for the purposes of the UFIA Bill.
2. If certain conditions are met, income or assets that are caught by the UFIA Bill are excluded from the purview of the taxpayer’s total income for the purposes of the IT Act.
3. The UFIA Bill adopts the same tax administration authorities/structure and their jurisdiction as per the ITA. The appellate process is also similar. The UFIA Bill specifies that appeals before a High Court must be heard by a minimum of two Judges.
4. All information submitted under the ITA can be used for the purposes of the UFIA Bill.

Conclusion

The Modi Government’s commitment to identify and stem the generation of ‘black money’ was in focus during the Budget with the Finance Minister stating that it was the “first and foremost pillar of his tax proposals”. The Government has made good on its promise and if administered correctly, the UFIA Bill may have a deterrent effect too. Safeguards have been provided in the UFIA Bill by requiring mandatory issue of notice to the taxpayer, granting the taxpayer the opportunity to be heard and requiring the Revenue to give reasoned orders in writing and recording them.

The UFIA Bill is comprehensive in its reach, impacting everyone from those returning to India after a stint abroad to those who are in India remitting funds abroad under the Liberalised Remittance Scheme; fund managers having carry structures to corporations having subsidiaries abroad. Considering the vast reach of the Bill and its stringent consequences, it is unfortunate to note that the UFIA Bill does not appear to make a distinction between legal and illegal structures. It would have been helpful if the legislation would have contained more guidance as to distinguishing factors. These could have served as useful reference points for the taxpayers, practitioners and the Revenue. As it stands now, it appears that the UFIA Bill imposes its strict consequences even where the structure has been set up in a legally compliant manner, if there has been a non-disclosure.

The UFIA Bill also proposes to amend the Prevention of Money Laundering Act, 2002 (PMLA) by including the offence of tax evasion as a predicate offence under the PMLA, thus enabling the confiscation of foreign assets unaccounted for and prosecution of persons involved. In the Budget, the Finance Minister had also proposed that the Foreign Exchange Management Act, 1999 be amended to provide that foreign assets held in contravention of the exchange control rules contained in this Act could trigger seizure and confiscation of assets in India of equivalent value. In addition, such contraventions should be punishable with upto 5 years’ imprisonment and penalty.

On 21 May 2012, the then Government had released its report titled ‘White Paper on Black Money’ in which it had discussed amnesty schemes as an option to bring back black money into India. That said, ad hoc measures to crackdown on tax-evaded income sweetened by short voluntary disclosure schemes have been criticized as disincentivising honest taxpayers. The Government-appointed Shome Committee had also recommended that amnesty schemes be scrapped for this reason.⁴ Instead of clean-up measures, it would be better to address the factors that incentivize people to take funds out of India and retain them abroad. For instance, further relaxation of capital controls (especially for transactions of individuals), greater clarity in tax laws from the beginning, efficient dispute resolution and positive engagement of the Revenue with the taxpayers are suggested as more durable measures to encourage a culture of compliance.

¹ This applies only to individuals. Generally, non-residents who relocate to India from abroad are considered to be ‘resident but not ordinarily resident’ for two years from the year in which they relocate.

² Extract from the Instructions to the tax returns:

“Financial interest would include, but would not be limited to, any of the following:-

(1) if the resident assessee is the owner of record or holder of legal title of any financial account, irrespective of whether he is the beneficiary or not.

(2) if the owner of record or holder of title is one of the following:-

(i) an agent, nominee, attorney or a person acting in some other capacity on behalf of the resident assessee with respect to the entity.

(ii) a corporation in which the resident owns, directly or indirectly, any share or voting power.

(iii) a partnership in which the resident assessee owns, directly or indirectly, an interest in partnership profits or an interest in partnership capital.

(iv) a trust of which the resident has beneficial or ownership interest.

(v) any other entity in which the resident owns, directly or indirectly, any voting power or equity interest or assets or interest in profits.

³ All India Federation of Tax Practitioners v Union of India, (1998) 231 ITR 24 (SC)

⁴ “Taxpayers keep waiting for amnesty schemes to be announced and take advantage of these schemes to build their capital”. The Committee’s Third Report to the Government in December 2014, http://articles.economictimes.indiatimes.com/2014-12-03/news/56684833_1_shome-panel-tax-amnesty-schemes-tax-administration-reform-commission