1. Continuation of Lower Withholding Tax Rate of 5% on Foreign Currency Borrowings
It is proposed to continue the withholding tax rate of 5% on interest on foreign currency borrowings before 1 July 2020. This would significantly incentivize multi-national companies to borrow from overseas at a nominal interest rate, for its business purposes and in a long way promote the growth of Indian operations. Further, the said lower rate of 5% has been also extended for interest on rupee denominated bond issued outside India before 1 July, 2020.
Further, the said rate of 5% shall also applicable in case of 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
2. Thin Capitalisation Regulations
As expected, thin capitalization concept has been introduced in this budget to counter cross-border shifting of profit through excessive interest payments, and thus aim to protect a country’s tax base. In line with the recommendations of OECD BEPS Action Plan 4, the interest expenses claimed by an entity to its associated enterprises shall be restricted to 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to associated enterprise, whichever is less.
This provision shall be applicable to an Indian company, or a permanent establishment of a foreign company being the borrower who pays interest in respect of any form of debt issued to a non-resident or to a permanent establishment of a non-resident and who is an ‘associated enterprise’ of the borrower. The provisions shall allow for carry forward of disallowed interest expense to 8 assessment years immediately succeeding the assessment year for which the disallowance was first made and deduction against the income computed under the head “Profits and gains of business or profession to the extent of maximum allowable interest expenditure. In order to target only large interest payments, it is proposed to provide for a threshold of interest expenditure of Rs. 1 crore exceeding which the provision would be applicable.
This would impact significantly the multi-national companies who may have interest bearing debts from group entities.
3. Clarification on Indirect Transfer
In 2012, Income-tax Act was amended to provide for taxation of those transactions of transfer of shares or interest in a foreign entity deriving its value substantially from Indian assets. There are apprehensions from the stake holders regarding transfer of stake of investors of India-based funds located abroad but investing in India-based companies.
In order to remove this difficulty, the Foreign Portfolio Investor (FPI) Category I & II shall be exempted from indirect transfer provision. Also a clarification shall be issued for non-applicability of indirect transfer provision in case of redemption of shares or interests outside India as a result of or arising out of redemption or sale of investment in India which is chargeable to tax in India.
This is a very welcome move and would bury the ghosts of taxation of indirect transfer which was ignited after the controversial Vodafone case.
4. Tax Neutral Conversion of Preference Shares into Equity
As per existing FDI policy, only convertible instruments are allowed to be issued to the foreign investors. The move of tax neutral conversion would help the foreign investors to convert their convertible preference shares into equity without any tax implications. This is a significant move and would incentivize FDI in India either in equity or in form of convertible preference shares.
5. Extension of Capital Gain Exemption to Rupee Denominated Bonds
With a view to provide relief to non-resident investor, the gains arising on account of appreciation of rupee against a foreign currency at the time of redemption of rupee denominated bond of an Indian company subscribed by him, shall be ignored for the purpose of computation of full value of consideration. The said benefit is also extended to secondary holders as well.
Further, with a view to facilitate transfer of Rupee Denominated Bonds from non-resident to non-resident, it is proposed to amend section 47 so as to provide that any transfer of capital asset, being rupee denominated bond of Indian company issued outside India, by a non- resident to another non- resident shall not be regarded as transfer.
6. Clarity on Taxation on Capital Gains arising on Transfer of Unlisted Shares by Non-residents
The long-term capital gains arising from the transfer of unlisted securities in case of non-resident is taxed @ 10% from 1 April 2013. There was an uncertainty as to whether the provision of section 112(1)(c)(iii) is applicable to the transfer of share of a private company. Finance Act, 2016 amended section 112(1)(c) to clarify that the share of company in which public are not substantially interested shall also be chargeable to tax @ 10% with effect from 1st April, 2017. As the concessional rate was provided with effect from 1st April, 2013, there was uncertainty about the applicability of the amendment to the intervening period. The said uncertainty has been put to rest and has been clarified that the amendment made by Finance Act, 2016 shall also apply to the period from 1 April, 2013 onwards. This clarificatory amendment would induce foreign investors towards stable tax regime.
7. Transfers for Inadequate Consideration Net Widened
The current provisions contained in section 56(2)(vii) & 56(2(viia) of the Income Tax Act are applicable in case of transfers for inadequate consideration exceeding Rs.50,000 where the recipient of property is Individual / HUF and firm and in certain cases, closely held companies.
Under the provisions of the new section 56(2)(x), the coverage of recipients as above has been broadened to coverall persons ( including listed companies and AOPs) who are in receipt of property (money/ immovable property / any other property)..
8. New Obligation of Tax deduction Cast on Individuals and HUFs (not covered under tax audit) for Rental Payments
Currently, there is no tax deduction obligation on the Individuals and HUFs (not covered under tax audit) to deduct tax on any payments made by them except for payment towards purchase of house property (for property above Rs. 50 lakhs) under section 194-IA. This budget has cast the tax net wide by requiring all such individuals and HUFs paying rentals to residents above Rs. 50,000 per month or part of the month, to deduct tax on payments @ 5%. This has been proposed through insertion of section 194-IB. Currently, there are significant penal provisions for ‘Assessees-in-default’ under section 201 who fail to deduct / pay tax under the Income Tax Act. As this is the first year of such an obligation being cast on Individuals / HUFs (other than covered under tax audit), there should be an suitable cushion provided to such new deductors in case of any non-compliances. However, the newly proposed section 194-IB provides that there shall be no requirement to obtain the Tax Deduction Account Number (TAN) for the deductors (Individuals and HUFs, in case where no tax audit is applicable).
9. Significant Impetus to more than 96% companies by reduction in Corporate Tax Rates to 25%
The Medium and Small Enterprises which constitute more than 96% of the companies filing their tax returns have been provided a huge corporate tax rate cut. It has been proposed to bring down the corporate tax rate to 25% in case of companies having a turnover of upto Rs. 50 crores in Financial Year 2015-16. This is a major relief as both the companies in the manufacturing and service sector, who are facing pressure on their bottomline and would improve the cash flows. This reduced tax rates would be a balancing act for all the companies who are bracing for a higher rate under the proposed GST legislation.
(Author is founder of Founder, RSM Astute Consulting Group)