While the Finance Bill 2020 seeks to enhance effectiveness, transparency and accountability of tax administration, the proposals (barring a few) are largely tepid. While there is likely to be some respite for taxpayers with the introduction of amnesty schemes to settle litigation, it could also open new areas for litigation.
The Finance Minister unveiled the Finance Bill, 2020 (Budget/Bill) for the financial year 2020-21 on 1 February 2020. Contrary to expectations of a broad fiscal stimulus of higher expenditure and lower taxes, the Budget surprised many for its focus on fiscal discipline. The tax proposals, barring a few impacting foreign investors, are largely tepid. Further, the Budget proposes an optional concessional tax regime for individual taxpayers who agree to forego various exemptions and deductions.
Earlier in the year, the government had boldly cut corporate tax rates to 22% for older companies and 15% for new manufacturing companies. The 15% tax rate is proposed to be extended to power generating companies as well. However, the emphasis of the Budget appears to be on attracting foreign investment – both equity and debt. For instance, the abolition of dividend distribution tax coupled with nil/reduced taxation on interest earned by foreign lenders/funds is likely to yield favourable results as far as foreign investment is concerned.
DIRECT TAX PROPOSALS
AMENDMENTS BENEFITING FOREIGN INVESTORS
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- Deletion of dividend distribution tax (DDT)Under the present tax regime, in addition to income-tax chargeable on the total income of domestic companies and mutual funds, any amount declared, distributed or paid by way of dividends is subject to DDT at an effective rate of 20.56%. Such dividend is then exempt in the hands of shareholders (or unitholders).The Bill proposes to abolish DDT and instead tax dividends (or income from units) in the hands of shareholders (or unit holders). In other words, dividend income will be included in the total income of the shareholders/unit holders. The Bill also proposes that the deduction for expense in respect of dividend income would be restricted to 20% of the dividend or income from units, and such expense would be in the nature of interest only.
Other significant changes include:
- Currently, a specific exemption for DDT is provided to special purpose vehicles in respect of dividends paid to a business trust (subject to certain conditions). Dividends paid by a business trust to unit holders are also exempt from tax. The Bill proposes that dividends received by a business trust from a special purpose vehicle would continue to be exempt. However, dividend income distributed by a business trust to a unit holder would be taxed in the hands of a unit holder.
- The Bill proposes to insert a new Section 80M to remove the cascading effect of tax when dividend is received by a domestic company from another domestic company, and thereafter the recipient company also declares dividends. However, this would be subject to fulfilment of prescribed conditions. Further, the cascading effect of a domestic company’s offshore investment has not been removed.
Amendments have also been proposed to withholding tax provisions. Domestic companies, business trusts and mutual funds would be required to withhold income tax on dividend income at the specified rates. Based on the wording of the law, it appears that withholding tax would apply to payment of dividend by a special purpose vehicle to a business trust even though such dividend income would be tax exempt in the hands of the business trust.This will however create an anomaly as such dividend income would be tax exempt in the hands of the business trust, as discussed above.
This amendment benefits multinational companies and foreign investors as this would improve the return on equity in Indian companies. Foreign investors were unhappy with the current DDT regime, particularly due to non-availability of DDT credit and concessional DDT rates (which vary between 5% to 15% in tax treaties), which led to multiple tax incidence. However, the change may have an adverse impact on domestic investors and promoters of Indian private-sector companies, who could end up paying additional tax on the same dividend income. For instance, promoters who are taxed at the highest rate could end up paying as much as 42.7% on the dividend they receive. This might result in alternative ways to repay shareholders such as buybacks.
- Exemption for certain income of Sovereign Wealth Funds and wholly owned subsidiary of Abu Dhabi Investment Authority (ADIA)In order to provide a boost to the infrastructure sector, the Bill proposes to introduce an exemption for income relating to investments made by sovereign wealth funds (that satisfy prescribed conditions) and wholly-owned subsidiaries of ADIA, in an enterprise carrying on the business of developing, or operating and maintaining, or developing, operating or maintaining specified infrastructure facilities. Specifically, dividend income, interest or long-term capital gains arising from such an investment would be tax exempt in the hands of the specified investor entities.In order to be eligible for exemption, the investment is required to be made on or before 31 March 2024 and held for at least 3 years.
- Extension of the concessional tax rate for Foreign Investors/Investments in long-term and rupee denominated bondsCurrently, a withholding tax at a concessional rate of 5% is applicable to interest paid by an Indian company or a business trust to a non-resident, for approved borrowings (between 1 July 2012 to 1 July 2020) in foreign currency from sources outside India (under a loan agreement or on issue of long-term infrastructure bonds). The concessional rate of 5% is also applicable for borrowings by a specified company or a business trust from a source outside India through issuance of rupee denominated bonds before 1 July 2020.In order to attract fresh foreign investment in infrastructure and stimulate the economy with external commercial borrowings, the Bill proposes to extend the period of concessional withholding tax rate from 1 July 2020 to 1 July 2023.
Further reduction of withholding tax rate to 4%
The Bill proposes a further rate reduction to 4% for withholding tax on the interest payable to a non-resident, for borrowings in foreign currency from a source outside India, through the issuance of any long term bond or RDB (on or after 1 April 2020 but before 1 July 2023), which is listed on a recognised stock exchange located in any International Financial Services Centre.
- Extension of eligible period of concessional tax rate for investments by Foreign Institutional Investors (FII) in debt instrumentsCurrently, a lower withholding tax rate of 5% is applicable for interest payable at any time on or after 1 June 2013 but before 1 July 2020 for investments by FIIs and Qualified Foreign Investors (QFIs) in Government securities and rupee-denominated corporate bonds.In order to attract fresh investments from FIIs, the Bill proposes to extend the concessional rate of 5% for withholding tax from 1 July 2020 to 1 July 2023.
The Bill also proposes to extend the concessional withholding tax rate to interest payments on municipal bonds, as Foreign Portfolio Investors (FPIs) have recently been permitted by the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) to invest in such bonds.
- Modification in conditions for exemption from ‘business connection’ for Foreign Investors/FundsCurrently, fund management activity carried out through an eligible fund manager acting on behalf of an eligible investment fund does not constitute business connection in India for the fund. Further, such eligible investment fund is not considered an Indian tax resident merely because the eligible fund manager undertaking fund management activities is located in India.However, this benefit is available subject to the fulfilment of certain conditions. One such condition, which relates to the eligibility of the fund, is that the aggregate participation or investment in the fund, directly or indirectly, by persons resident in India should not exceed 5% of the corpus of the fund. This condition is difficult to comply with because eligible fund managers, who are Indian tax residents, are required to demonstrate that they have ‘skin in the game’ to attract investment. Accordingly, the Bill proposes that the contribution of the eligible fund manager of upto INR 250 million during first three years will be excluded from the calculation of the aggregate participation or investment in the fund, directly or indirectly, by persons resident in India.
Another condition relating to the eligibility of the fund is that the monthly average of the corpus of the fund should not be less than INR 1 billion, except where the fund has been established in the same financial year as being assessed. In such a case, this condition is required to be fulfilled at the end of a period of six months from the last day of the month of its establishment, or at the end of such financial year, whichever is later. Therefore, there is a disparity in the period available for fulfilling this condition in the year of establishment, depending upon when the fund is established in the given financial year. A fund set up in the latter half of the financial year has a shorter period of time to comply with this condition as compared to a fund set up in the first half of the financial year. Accordingly, to remove this disparity, it is proposed that if the fund has been established in the financial year being assessed, the condition relating to monthly average of the corpus of the fund should be fulfilled within 12 months from the last day of the month of its establishment.
These amendments will apply in relation to financial year 2019-20 and subsequent years.
- Exclusion of permanent establishments (PE) of foreign banks from the ambit of thin capitalisation provisionsCurrently, the deductible interest or similar expenses exceeding INR 10 million of an Indian company, or a PE of a foreign company, paid to the associated enterprises (AE) is restricted to 30% of its earnings before interest, taxes, depreciation and amortisation or interest paid.However, as per the existing provisions of the (Indian) Income Tax Act, 1961 (ITA), a branch of a foreign company in India is deemed to be a non-resident in India. Further, the definition of AE deems two enterprises to be AEs if, during the financial year, a loan advanced by one enterprise to the other enterprise is equivalent to 50% or more of the book value of the total assets of the enterprise taking the loan. Therefore, the interest payable for a loan from the branch of a foreign bank may attract provisions of interest limitation. Considering representations made by taxpayers to this effect, the Bill proposes to carve out the interest paid for a loan by a lender which is a PE of a non-resident person engaged in banking in India.
- Exemption from filing returns for non-residentsCurrently, there is an exemption from filing tax returns in India for a non-resident whose total income consists of certain dividend or interest income (as provided under the ITA), if tax is deducted at source at the applicable rate on such income.The Bill proposes to extend this exemption to income earned by a non-resident as royalty or fees for technical services which is not effectively connected with a PE in India. However, non-residents who rely on treaties for lower withholding tax rate cannot avail this exemption.
This amendment will apply in relation to returns to be filed for financial year 2019-20 and subsequent years.
- Modification of the definition of ‘business trust’ to include private unlisted InvITsCurrently, the term ‘business trust’ means a trust registered as an infrastructure investment trust (InvIT) or a real estate investment trust (ReIT) under the relevant SEBI regulations and whose units are required to be listed on a recognised stock exchange. Through amendments in April 2019 SEBI removed the requirement for units of an InvIT to be listed on a stock exchange.In order to provide the same tax treatment to private unlisted units of InvITs, such as that provided to public listed InvITs, the Bill proposes to remove the requirement of listing the units of the business trust on a recognised stock exchange from the definition of ‘business trust’.