The Budget this year is especially important, as it will be the first Budget by the Government after re-election with thumping majority and first to be presented by Nirmala Sitharaman after taking over from the previous Finance Minister, Mr Arun Jaitley. With only four weeks into her new role, it would be interesting to see the Budget proposals introduced this year.
Notably, Mr Piyush Goyal, acting as interim Finance Minister, had presented a vote on account Budget in February earlier this year. This Government is credited with introducing key reforms such as Goods and Services Tax, Insolvency and Bankruptcy Code, 2016 (IBC), Benami Transactions (Prohibition) Amendment Act, 2016, Real Estate (Regulation and Development) Act, 2016, Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015. Furthermore, it also introduced measures to align with the international tax practices of Base Erosion and Profit Shifting (BEPS) guidelines and Thin Capitalisation norms, etc.
Amongst other things, these legislations and reforms affect the corporate reorganisations. Business reorganisation is imperative for growth of any business as it entails various benefits, such as focusing on core competency, operational synergies, maximisation of shareholders’ value, cost reduction, expansion into new avenues, etc. However, any business reorganisation is affected by the amendments in tax framework.
India has been one of the fastest growing economy in the world in the recent past. However, in the first half of 2019, India has lost this position, after growing slower than expected. The Budget is an avenue for the nation to propel its economic growth. While the Interim Budget did not have an expanded section for tax proposals, there are increasing expectations from this full Budget. As the industry eagerly awaits Union Budget 2019, we list down expectations, which are imperative from business restructuring perspective:
1. Reduction of corporate tax rate
Last year, the corporate tax rate was reduced to 25% (plus applicable surcharge and cess) for domestic companies having total turnover of less than INR 2.5bn in FY 2016-17. This is in line with earlier proposals of the erstwhile Finance Minister in 2015, of reducing the tax rates for companies to 25%. The exemption was broad enough to cover a significant number of tax-paying companies, and it would be interesting to see if the Government will reduce the corporate tax rates for large companies to 25% in line with Mr Jaitley’s Budget speech for the Union Budget, 2015.
2. Legislative amendment for tax exemption on interest on Rupee-Denominated Bonds
In order to increase the foreign exchange inflow through low cost foreign borrowings in the form of off-shore Rupee Denominated Bond, the Central Board of Direct Taxes (CBDT) issued a press release in September 2018 providing tax exemption (under section 194LC) for interest payable by an Indian company or a business trust to a non-resident on rupee-denominated bonds issued outside India during the period 17 September 2018 to 31 March, 2019. However, the sunset of 31 March, 2019 was not extended in the Interim Budget, 2019. In line with the Government’s objective to increase the forex fund flow, this exemption may be extended further.
3. Applicability of recipient tax provisions on fresh issuance of shares
Recipient tax provisions (i.e. section 56(2)(x)) provides for taxation of income where shares are received for “no or inadequate consideration.” There has been an ambiguity that whether these provisions are applicable only on receipt of shares pursuant to transfer but also on receipt of shares pursuant to fresh issuance by a company.
The CBDT issued a clarification on non-applicability of section 56(2)(viia) (which is similar to section 56(2)(x)) on the fresh issue of shares in December 2018, which it subsequently withdrew in January 2019. The CBDT stated that the matter is sub-judice in certain higher judicial forums and that various representations have been received from stakeholders seeking clarification on other similar provisions in section 56; thus, it will issue a comprehensive circular on the subject in due course.
Further, as per a recent CBDT circular, the Finance Minister has stated that appropriate remedial measure shall be applied for tax assessments where the first mentioned circular which was subsequently withdrawn, has been taken into account during the course of assessment proceedings.
In addition, the above provision creates hardship for prospective Bidders for companies under the IBC, particularly listed companies where fresh shares are being traded at much higher values than the negligible fair value.
Considering that the applicability of recipient tax implications provisions on the infusion of capital has been a subject matter of litigation, clarity on this aspect is necessary.
4. Tax amendments needed in view of Insolvency and Bankruptcy Code, 2016 (IBC):To promote restructuring plans under IBC, last year’s Budget introduced tax incentives for companies under IBC, such as the ability to carry forward losses despite change in ownership and Minimum Alternate Tax (MAT) relief to the extent of aggregate of unabsorbed depreciation and carried forward loss. However, certain clarification and exemptions are still required on this front as follows:
√ Exemption for IBC companies for carry-forward of unabsorbed tax losses
The tax laws provide that on change in shareholding by more than 49% of a company under IBC, the past business losses (which are otherwise not allowable to be carried forward by companies) can be carried forward by the company provided an opportunity to be heard is provided to the income-tax authorities during the IBC process.
However, there is no clarity on who shall be responsible for providing an opportunity of being heard to the income tax authorities i.e. whether the bidder or the Resolution Professional or the National Company Law Tribunal (NCLT). Therefore, clarity on this is necessary.
√ Write-back of loans:Companies under the insolvency resolution process of IBC carry huge unserviceable debt in their balance sheet. Under the current tax regime, the write-back of such loans may be subject to MAT. The MAT provisions allow the reduction of the sum of both unabsorbed book loss and unabsorbed book depreciation from the amount of Book Profits for the purpose of levy of MAT on companies under insolvency resolution.
– However, this does not address the MAT issue completely, as the unabsorbed losses and unabsorbed depreciation may not have any correlation with the loans written back (which are based on negotiations with Banks and contain a capital element); thus, it may not be sufficient in all cases to exhaust the book profits on account of write-back of loans. Thus, it is necessary to introduce legislative amendments providing complete tax exemption for companies under the IBC.
– Further, the law provides that the aggregate unabsorbed book loss and unabsorbed book depreciation shall be allowed as deduction from the Book Profits. However, it does not clarify whether such carried forward unabsorbed books loss and depreciation is to be taken as per books of accounts or as per the tax records. While MAT provisions are applicable on profits as per books of accounts, and thus, the intent seems to be that the said amounts as per books of accounts are to be taken considering these are MAT provisions. However, clarity in this matter is needed to avoid litigation.
√ Clarity on past tax claims of the insolvent company: While the IBC law provides for settlement of all admitted claims of a company under insolvency, clarity is required on the treatment of tax claims in case of ongoing litigation, and where the tax department is yet to raise a demand.
The Income-tax law should provide complete tax neutrality, including under MAT provisions, while implementing the Resolution Plan as approved by the NCLT under the IBC.
5. MAT on transition to Ind AS: Current MAT provisions levy MAT on the transition amount, i.e., items of Other Equity (excluding capital reserve and securities premium reserve) appearing on the first day of Ind AS adoption in five equal instalments starting from the financial year in which the company first adopted Ind AS. Further, any gain on the transition amount decreases the unabsorbed book losses of the company, and accordingly, lowers the amount of book losses and depreciation available for set-off against MAT gains. This leads to double impact of the same transition amount adjustment. Accordingly, clarification on the above is much required.
6. Clarification on availability of Extended carry forward period for MAT credit – The period for carry forward of MAT was extended from 10 years to 15 years by the Finance Act, 2018. However, the provisions do not clarify whether the extended period of 15 years would be available in those cases where original period of 10 years has already expired before the date on which such provision came into force. Thus, clarity on this aspect should be issued.
7. Rationalisation of tax provisions for start-ups: The Department for Promotion of Industry and Internal Trade (DPIIT) issued a notification in February 2019, wherein an entity shall be considered as a start-up if its turnover for any of the financial years since incorporation does not exceed INR 100 crores vis-à-vis INR 25 crores limit prescribed earlier. Despite this increase in the turnover limit for eligibility criteria, section 80-IAC of the income-tax law restricts the benefit of tax deduction on business profits to start-ups for specified period to only those start-ups whose turnover is not more than INR 25 crores in the year for which deduction is claimed. Accordingly, the aforesaid tax provisions should align with the amendment for start-up eligibility criteria to provide benefits to all start-ups.
8. Rationalisation of dividend tax provisions:The erstwhile FM himself, in his Budget speech in 2016, had commented that the “Dividend Distribution Tax (DDT) is perceived to distort the fairness and progressive nature of taxes” as the rationale behind introducing a new tax on dividends in the hands of specified shareholders. Since DDT is a company-level tax and not a shareholder-level tax, non-resident shareholders of Indian companies often face challenges in availing tax credit in their respective countries of residence against the tax paid by the Indian company in the form of DDT. Therefore, DDT should be abolished and instead tax should be levied on the shareholder.
9. Tax neutrality in case of cross border mergers:Cross-border merger, i.e. inbound merger of a foreign company into an Indian company and outbound merger of an Indian company into a foreign company is permitted both under the Companies Law as well as foreign exchange norms. Tax neutrality provisions in case of outbound merger should also be introduced.
10. Fair value recording v. book value recording on demerger: As per Ind-AS provisions, in case of demerger of a business undertaking to a Resulting Company being a company which is not an entity under common control, the Resulting Company needs to record assets received in the demerger at respective fair values. However, under the income-tax regulations, a demerger qualifies to be tax-neutral only when the property and liabilities of the undertaking transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger. Thus, the same may have an impact on tax neutrality of demerger which does not seem to be the intention of the law. Accordingly, provisions should be brought in to eliminate the conflict between Ind-AS and income tax.
11. Carry forward of tax losses for all businesses and not limiting it to industrial undertakings: In case of merger of companies, the carry forward of tax losses is permitted only for companies owning an industrial undertaking and certain other specified categories of companies. This is severally impacting reorganization in service companies. Thus, carry forward of tax losses should be permitted for all businesses and should not be limited to industrial undertakings.
12. Carry forward of MAT credit in mergers/ demergers: Currently, there are no provisions in the income-tax law for the carry forward of MAT credit on corporate reorganisations such as mergers and demergers. Enabling provisions should be introduced for the same.
13. Tax-neutrality on conversion of company into LLP: Presently, the conversion of a company into LLP enjoys tax-neutrality subject to satisfaction of specified conditions, which may not be fulfilled in case of large companies. Tax-neutrality provisions for conversion of company into LLP should be provided without any conditions.
14. Tax neutrality on merger of foreign companies
a) Tax neutralityon merger of foreign subsidiaries held by Indian companies
The current tax regime provides tax neutrality on transfer of a capital asset being shares of an Indian company by the amalgamating foreign company (F Co1) to amalgamated foreign company (F Co2) provided at least 25% of the shareholders of F Co1 continue to remain shareholders of F Co2, and such transfer does not attract capital gains tax in the country where amalgamating company (F Co1) is incorporated.
However, presently, no provision provides tax neutrality to an Indian holding company on merger of its foreign subsidiary with another foreign company; hence, the Indian Hold Co is subject to tax on such amalgamation even if such amalgamation is exempt in foreign jurisdiction. Tax neutrality provisions in for such Indian Hold Co should be provided.
b) Tax neutralityfor shareholders on merger of foreign companies
> As mentioned above, presently capital gains pursuant to transfer of a capital asset being shares of an Indian company by the amalgamating foreign company (F Co1) to amalgamated foreign company (F Co2) are exempt in the hands of amalgamating foreign company subject to specified conditions.
> In addition, the law provides capital gains tax exemption to foreign amalgamating company (F Co1) on transfer of capital asset being shares of another foreign company (F Co2) deriving substantial value from Indian assets to the amalgamated foreign company (F Co3) on merger, subject to specified conditions.
However, in both of the above scenarios, no exemption from capital gains on indirect transfer has been provided to the shareholder of foreign amalgamating company (F Co1) where F Co1 derives substantial value from India. Therefore, amendment in this regard should be brought in.
15. REITs/ InvITs
√ Income-tax provisions provide for lapse of losses on change in more than 49% voting power in a company. However, the said provisions should not apply on change in shareholding of SPVs in the event of swap of shares of SPVs by holding company in exchange of units of REIT/ InvIT.
√ Presently, the holding period for long-term capital gains on listed shares is 12 months. Considering the units of REITs and InvITs are also listed, the holding period for units of REITs and InvITs should be 12 months instead of 36 months (as in case of shares of listed companies) for the purpose of determining capital gains tax on the transfer of such units.
16. Lapse of losses on change in shareholding pursuant to amalgamation/ demerger of Indian companies
As mentioned above, income-tax provisions provide for lapse of losses on change in more than 49% voting power in a company. Restriction on carry-forward of losses does not apply when there is a change in shareholding of an Indian company by more than 49% as result of amalgamation/ demerger of two foreign companies, provided at least 51% of the shareholders of the amalgamating foreign company continue to be shareholders of the amalgamated foreign company. However, similar benefit is not provided in case of amalgamation/ demerger of two Indian companies involving change in shareholding of more than 49% of another Indian company. This affects the restructuring of Indian companies, even though it is necessitated by commercial reasons.
Accordingly, the said benefit should be provided for carry-forward of losses in case of amalgamation/ demerger of two Indian companies involving change in shareholding of more than 49% of another Indian company.
17. Tax neutrality on merger of LLP into Company:Current tax regime has specific provisions for the tax neutrality of amalgamation and demerger of companies subject to fulfilment of specified conditions. With the advent of more flexible forms of entity structures in India, such as LLPs, and the Chennai Tribunal’s favourable decision on the permissibility of merger of an LLP into a company, there is a necessity to align the benefits of tax neutrality on restructuring viz. amalgamation/ demerger available to companies to LLPs. as well and thus, specific provisions on the tax neutrality of the same are required to be introduced.
18. Reduction of capital gains tax rate of unlisted shares: Presently, in case of resident shareholders long-term capital gains on whereas for non-resident shareholders, the long term capital gains on unlisted shares are taxed at 10% (plus applicable surcharge and cess). Capital gains tax rate for unlisted shares should be reduced from 20% to 10% for resident shareholders also.
Many of these clarifications have been long-standing demands of the industry and it is interesting to see if the Budget 2019 brings in any clarity in this regard.
The views expressed in this article are personal to the author. This article includes inputs from Mehak Ahuja – Manager – M&A Tax, PwC India.
Author: Amit Bahl – Partner, M&A Tax, PwC India and Harsh Biyani – Director, M&A Tax, PwC India