Minimum Alternative Tax (MAT)
Current situation: In light of the tax holiday available to the Power and Oil and Gas sector, MAT is a key provision impacting the sector. Currently, MAT is applicable at the rate of 18 percent (effective 19.93 percent considering surcharge and cess) of the book-profits computed after making specified adjustments to the net profit of the company. Further, the companies are allowed to carry forward the MAT credit (which is the excess of MAT tax paid over the tax computed in accordance with normal corporate tax provisions) to future years.
DTC Proposals: Under the Direct Tax Bill 2009, it was proposed that company shall pay tax on its gross assets at the rate of 2 percent. (0.25 percent in case of banking companies) if the tax liability is less than the tax on gross assets. The revised draft of the DTC reintroduced profit based MAT .Under the DTC, the rate has been increased from 18 percent to 20 percent of book profits.
Our Comments: DTC Bill 2009 had proposed to levy MAT on the basis of gross assets, which would had been a dampener for capital based industry like power, oil and gas. However, DTC has brought back MAT to Book Profits which is a positive step towards development of the industry.
Corporate tax provisions – Key provisions
Tax rates
Current Situation: Currently, the domestic companies are subject to corporate tax of 30 percent (plus surcharge and education cess) on their taxable income
DTC Proposals: While the Direct Tax Code Bill, 2009 stipulated the corporate tax rate as 25 percent, the Revised Discussion Paper had hinted that tax rates could be reviewed and suitably calibrated considering the reduction in the tax base due to certain tax benefits spelt out in the said paper.
The DTC now has retained the existing corporate tax rate of 30 percent.
Our Comments: Maintaining the corporate tax rate at 30 percent is not a positive development; in as much as other levies such as DDT of 15 percent and branch profit tax of 15 percent make the effective tax rate quite high.
Test of Residency
Current Situation: Under the provisions of the Act, a company is resident in India in any previous year, if the control and management of its affairs is situated ‘wholly’ in India.
DTC Proposals: Under DTC, it is proposed to shift the test of residence of a company from ‘control and management’ to ‘place of effective management’ in line with international practice.
Accordingly, a company incorporated outside India will be resident in India, if its ‘place of effective management’ is situated in India.
Place of effective management of the company would mean:
- Place where the board of directors or its executive directors make their decisions
- In cases where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions.
Our Comments: Although the concept of ‘place of effective management’ proposed under DTC is in line with international practice, it is important that this provision is administered in a fair and pragmatic manner. The new residency definition could impact businesses where key decisions are taken by Indian management / executives and merely adopted by the board overseas.
Treaty Override
Current Situation: Under the Act, the provisions of the tax treaties prevail over the domestic law to the extent they are more beneficial to the taxpayer.
DTC Proposals: The initial draft of the Direct Tax Code Bill, 2009 provided that in the case of a conflict between the provisions of a treaty and the provisions of the Code, the one that is later in point of time shall prevail. This led to apprehensions whether the proposal would lead to treaty override and render the existing treaties otiose. Post the Revised Discussion Paper, the DTC seeks to restore the beneficial treatment between the Act and the Tax Treaty except in specified cases-
- where GAAR is invoked or
- when CFC provisions are invoked or
- when Branch Profits Tax is levied.
Our Comments: The proposals seem to be in line with international practice.
Controlled Foreign Corporation (CFC) Provisions
Current Situation: Under the Act, there are no CFC provisions.
DTC Proposals: The introduction of the CFC provisions has come as a major surprise for India Inc. The CFC provisions have been brought in as an anti-avoidance measure. Under this, passive income earned by a foreign company controlled directly or indirectly by a resident in India, and where such income is not distributed to the shareholders, resulting in deferral of taxes shall be deemed to have been distributed to the shareholders in India. The CFC provisions are broadly summarized as under:
- The total income of a Resident taxpayer to include income attributable to a CFC which means a foreign company:
– that is a resident of a territory with lower rate of taxation (i.e. where taxes paid are less than 50 percent of taxes on such profits as computed under the DTC)
– whose shares are not listed on any stock exchange recognised by such territory
– individually or collectively controlled by persons resident in India (through capital, voting power, income, assets, dominant influence, decisive influence, etc.)
– that is not engaged in active trade or business (i.e. it is not engaged in commercial / industrial / financial undertakings through employees / personnel or less than 50 percent of its income is of the nature of dividend, interest income, income from house property, capital gains, royalty, sale of goods/services to related parties, income from management, holding or investment in securities/shareholdings, any other income under the head income from residuary sources, etc.)
– has specified income of such company exceeds INR 2.5 million.
- Tie breaker tests have been provided to determine the place of residence of a controlled foreign company.
– Scope of passive income also covers supply of goods / services to associated enterprises
– Specific formula prescribed for computing income attributable to a CFC. Income attributable to the CFC to be based on specified income. Specified income to be based on the net profit as per the profit and loss account of the CFC, subject to prescribed adjustments.
Our Comments: CFC provisions are likely to bring additional complexity in the tax legislation and could significantly impact Indian companies having outbound investment structures. Specifically, CFC provisions could create cash flow problems for Indian companies since they would be subject to tax without corresponding receipt of actual dividends. This may necessitate a review of the existing overseas investment structure
Exempt-Exempt-Taxable (EET) vs. Exempt-Exempt-Exempt (EEE) Regime for Saving Schemes
Current Situation: Under the Act, long-term saving schemes like Government Provident Fund (GPF), Recognized Provident Fund (RPF), Public Provident Fund (PPF), Life Insurance, etc. are covered under the EEE method, wherein the contributions, accumulations / accretions thereto and the withdrawals are exempt from tax.
DTC Proposals: All long-term retrial savings schemes moved to EEE regime as against EET proposed earlier. Deduction in respect of investment in approved funds such as Provident Fund, Superannuation Fund or Pension fund reduced to INR 100,000 from INR 300,000. Receipts under a life insurance policy on death/maturity would be exempt from tax.
Our Comments: The continuation of EEE regime is a welcome step as it will provide a tax free lumpsum amount to individuals to meet their post-retirement financial requirements.
Withholding tax provisions – Others
Current Situation: The withholding tax rate on royalty and fees for technical services payable to non-residents is 10 percent (excluding surcharge and education cess).
DTC Proposals: The withholding tax rate in respect of payment of royalties and FTS to non-residents is proposed to be increased to 20 percent.
Our Comments: The higher withholding tax rates would increase the overall cost of the Indian companies in case of payments to tax residents of the country with whom India does not have a Tax Treaty and grossing up of tax is required in case of tax is borne Indian company.
Transfer Pricing
Current Situation: Currently, there are no provisions under the Act in respect of Advance Pricing Arrangement (‘APA’).
DTC Proposals: It is proposed to introduce APA for upfront determination of pricing methodology of an international transaction.
Our Comments: Whilst the scheme specifying the procedure of APA has not yet been released, the industry would expect that the same is in line with the international practice.
Leased Assets
Current Situation: In the absence of any specific provision under the Act, there is a lack of clarity surrounding the treatment of assets obtained on finance lease by Power and Oil and Gas sector undertakings. In certain cases, companies are facing litigation from revenue authorities on the question of whether they are eligible to claim depreciation on such assets.
DTC Proposals: Under DTC, the lessee would be treated as the owner of assets obtained on finance lease and therefore, eligible to claim depreciation on the same.
Our Comments: This is an important provision for the companies in Power and Oil and Gas sectors and it will help to end the long drawn litigation regarding ‘ownership’ of such assets and depreciation eligibility with the Revenue authorities.
General Anti Avoidance Rule (‘GAAR’)
Current Situation: Under the Act, there are limited specific anti-abuse provisions.
DTC Proposals
- The Code seeks to introduce GAAR which provides sweeping powers to the Revenue authorities. The same is applicable to domestic as well as international arrangements.
- GAAR provisions empower the Commissioner of Income-tax (“CIT”) to declare any arrangement as “impermissible avoidance arrangement” provided the same has been entered into with the objective of obtaining tax benefit and satisfies any one of the following conditions:
– It is not at arm’s length
– It represents misuse or abuse of the provisions of the DTC
– It lacks commercial substance
– It is carried out in a manner not normally employed for bona fide business purposes
- An arrangement would be presumed to be for obtaining tax benefit unless the tax payer demonstrates that obtaining tax benefit was not the main objective of the arrangement.
- CIT to determine the tax consequences on invoking GAAR by reallocating the income or disregarding/recharacterizing the arrangement.
- Meaning of ‘tax benefit’ widened to include any reduction in tax bases including increase in loss
- GAAR provisions to be applicable as per the guidelines to be framed by the Central Government
- GAAR shall override Tax Treaty provisions
- Forum of DRP available in a scenario where GAAR is invoked. Our Comments:
The guidelines to be issued by the Central Government would need careful examination to assess the scope and impact of these provisions. It is an open question whether GAAR can be invoked for transactions undertaken prior to the enactment of DTC. A suitable clarification may be provided for this purpose.
Indivituals should be given options to invest 5times there tax liablility in any of the tax saving products as desired, This will increase govt revenue & overall savings rate.