The draft Direct Taxes Code (DTC) along with a Discussion Paper was released on 12 August 2009 for public comments with the intention to simplify direct tax legislation in India. Subsequently, comments were solicited from the public and examined by the Government. A Revised Discussion Paper which is meant to respond to the major concerns and comments of stakeholders has now been released on 15 June 2010.

In view of the changes proposed and concessions given, it is expected that the proposals would lead to a reduction in the original tax base proposed in the DTC. The indicative tax slabs, tax rates, monetary limits for exemptions and deductions proposed in the DTC will, therefore, be calibrated accordingly while finalizing the legislation.

Key Highlights

While the text of changes to the statute are awaited, it has been indicated that the Revised Discussion Paper does not address all changes and there will possibly be more changes when the final DTC Bill makes its way to Parliament. This alert provides key highlights of the Revised Discussion Paper relevant to FIIs:

Capital Gains

Original Proposals under the DTC

  • Income from all investment assets to be computed under the head „Capital Gains?.
  • Capital gains to be subject to tax at 30% in case of non-residents and at the applicable marginal rate in the case of residents.
  • Distinction between short-term investment asset and long-term investment asset on the basis of the length of holding of the asset to be eliminated.
  • Capital gain to be reckoned as equal to full consideration minus cost of acquisition, cost of improvement and incidental expenses.
  • If capital asset has been transferred after one year from the end of the financial year in which acquired; the cost of acquisition and cost of improvement to be indexed.
  • The base date for determining cost of acquisition to be shifted from 1.4.1981 to 1.4.2000.
  • Securities Transaction Tax (STT?) to be abolished.
  • Foreign Institutional Investors were proposed to be liable to withholding tax on capital gains
  • Proposal to introduce the Capital Gains Saving Scheme for rollover of gains.

Issues and concerns raised

  • Withdrawal of the existing tax regime will significantly raise tax liability and possibly affect the capital markets.
  • capital gains tax rate of 30% in the case of non-residents was very high.
  • Foreign Institutional Investors should not be liable to withholding tax on capital gains, instead the payment of advance tax should be continued as under the existing provisions.

Revised Discussion Paper

Taxation of Capital Gains

  • The income arising on purchase and sale of securities by an FII shall be deemed to be income chargeable under the head “capital gains?. Accordingly income from purchase and sale of specified securities e.g. shares, units, debt securities, treasury bills, derivatives, security receipts, commercial paper etc should be capital gains and not business income.
  • The base date for determining the cost of acquisition to be shifted from 1.04.1981 to 1.04.2000. Consequently, all unrealized capital gains on assets between 1.4.1981 and 31.3.2000 not to be liable to tax.
  • The capital gain arising from transfer of any investment asset held for less than one year from the end of the financial year in which it is acquired will be computed without any specified deduction or indexation. It will be included in the total income and will be charged to tax at the rate applicable to taxpayer.
  • The capital gains from all investment assets will be aggregated to arrive at the total amount of current income from capital gains. This will, then, be aggregated with unabsorbed capital loss at the end of the immediate preceding financial year (unabsorbed preceding year capital loss) to arrive at the total amount of income under the head “Capital gains”. If the result of the aggregation is a loss, the total amount of capital gains will be treated as „nil? and the loss will be treated as unabsorbed current capital loss at the end of the financial year.

Double Tax Avoidance Agreement (DTAA) vis-à-vis domestic laws

Original proposal under the DTC

  • Neither a DTAA nor the DTC to have any preferential status by reason of its being a treaty or law. In the case of a conflict between the treaty and the DTC, the one later in point of time to prevail.

Issues and concerns raised

  • A general treaty override rule would render existing DTAAs redundant and is against the spirit of the Vienna Convention.
  • Bilateral agreements cannot be re-notified unilaterally so it may not be possible to restore the preferential status of DTAAs over domestic law for all existing DTAAs.
  • The proposal would result in higher rates of taxation on royalty, fees for technical services and interest income etc. currently taxed in the source country at a concessional rate as per the provisions of the DTAA.
  • The proposal could affect the inflow of foreign direct investments

Revised Discussion Paper

  • The domestic law or the relevant DTAA, whichever is more beneficial to the taxpayer, to be applied.
  • DTAA to have a preferential status over domestic law except in the following circumstances (limited treaty override):

± when General Anti-Avoidance Rules (GAAR) is invoked, or

± when CFC provisions is invoked, or

± when Branch Profits Tax is levied.

General Anti-Avoidance Rules

Original proposal under the DTC

  • GAAR to be introduced to deal with specific instances where a taxpayer enters into an arrangement, the main purpose of which is to obtain a tax benefit and such arrangement is entered or carried on in a manner not normally employed for bona-fide business purposes or is not at arm?s length or abuses the provisions of the DTC or lacks economic substance.

Issues and concerns raised

  • GAAR provisions are sweeping in nature and may be invoked by the tax authorities in a routine manner.
  • No distinction between tax mitigation and tax avoidance as any arrangement to obtain a tax benefit may be considered as an impermissible avoidance arrangement.
  • To avoid arbitrary application of the provisions:

± legislative and administrative safeguards should be provided for invoking GAAR; and

± suitable threshold limits should be provided for invoking GAAR.

Revised Discussion Paper

  • GAAR proposed to be retained in its existing form.
  • It is clarified that every arrangement for tax mitigation is not to be classified as an impermissible avoidance agreement.
  • Safeguards proposed to be introduced for invoking GAAR provisions:

± Central Board of Direct Taxes to issue guidelines to provide for the circumstances under which GAAR may be invoked.

± threshold limits to be prescribed for initiating GAAR provisions.

± the forum of Dispute Resolution Panel to be made available where GAAR provisions are invoked.

Source: Revised Discussion paper on The Direct Taxes Code released on 15 June 2010.

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September 2021