Withholding Tax on E-commerce Transactions: Is the Squeeze Worthwhile?

1. Preamble

1.1. E-commerce has transformed the manner in which business, especially in consumer goods, is done in India.  This has been so especially with the ease of availability of smartphones and internet facilities in most areas of India.  With over 560 million[1] internet users, India has just shot past the United States of America as the second largest online market just behind China.

1.2. So as to widen and expand the tax base, the Budget 2020 has proposed to provide for a withholding tax (tax deduction at source or 'TDS') on e-commerce transactions under section 194-O of the Income-tax Act, 1961 ('Act').  The proposed section would require e-commerce operators to deduct taxes at the rate of 1% on the sale of goods or provision of services by ecommerce participants, where the sale / provision is facilitated by the ecommerce operator through a digital or electronic facility or platform for ecommerce.  These provisions apply to transactions undertaken on or after April 1, 2020.  In this article, we have discussed the applicability of the proposal and the key implications arising for the sector.

2. Who is obligated to deduct tax?  The 'marketplace' operators in B2C and B2B segments are liable to deduct the tax

2.1.  E-commerce operator ('operator') has been defined in an exhaustive manner, to mean, any person:

o  Who owns, operates or manages any digital or electronic facility or platform, and

o  Is responsible for paying to an ecommerce participant.

2.2. Tax is to be deducted at the time of credit of amount of sale / service or both to the e-commerce participant ('participant' or 'seller') or at the time of payment, whichever is earlier.

2.3. E-commerce operators typically adopt a 'marketplace' or an 'inventory' model.

Marketplace (including aggregator) models: Under this model, the e-commerce operator typically owns / manages / operates the e-commerce platform and facilitates the transaction between the customers and sellers; the operator may enter into settlement of dues with the e-commerce participant. In a pure aggregator model, the participants sell their goods / services under the brand of the operator (e.g. cab service aggregators), while in the marketplace model the participants sell their goods or services under the respective brands (e.g. online retail),

Inventory-based model: Under this model, the e-commerce operator holds the goods which the customer purchases from the e-commerce operator (also referred to as the buy-sell model).  The model will either not have any e-commerce participant or where it does, such participant would not own / hold the goods.

2.4. The proposal seeks a TDS on the transaction involving the sale of goods or services of the ecommerce participant which is facilitated by the operator. Thus, this obligation should apply only to the market-place operators.

2.5. Further, the provision defines operators as persons who own, operate or maintain the digital facility or platform and also “is responsible for paying” to the participants. The phrase “responsible for paying” would typically mean that the operator is contractually obligated to organise the payment, to the participant, for the sale of such goods or services. In our experience, the operators do not take the contractual obligation of making the payments to the participants but only represent that they would facilitate a payment collection.

An ambiguity does arise on the aspect where the provision seeks to cover cases where payments are made directly by the customers to the sellers e.g. cash on delivery / for service.  The intent of using the phrase “is responsible for paying” in the definition of an ecommerce operator is not very clear.

Based on a holistic reading of the provision, it is inferred, the legislature intends to cover scenarios involving operators who facilitate the sales 'booking' and tracking the payment settlement irrespective of the fact that the payment is made directly to the seller or through the platform.  This view is fortified if one were to consider the primary provision which states that sale of goods or services is facilitated by the ecommerce operator through its digital or electronic facility or platform.

In this backdrop, it is also inferred that the following are not covered under the ambit of section 194-O:

o entities operating portal which facilitate mere listing (e.g. online directories) of the brands are not covered since they neither facilitate a sales booking nor a payment settlement;

o banks / payment gateways operating online portals which promote the products or services of different brands e.g. 'smart buy' offers by banks, since though the payment may be facilitated, they do not facilitate the sales booking and operate more as a lead generator.

Having stated the above, it would be welcome if the Government clarifies this aspect specifically.

3. Which income is being subjected to the tax deduction at source?  The income of the Sellers or Service providers whose goods / services are 'booked' through the operator.

3.1. The proposal provides for deduction of tax from the amounts payable to the participants i.e. sellers or service providers.  TDS at 1% is proposed on the gross amount of sales or services or both made by the seller.

3.2. An ambiguity does arise on whether the phrase 'gross amount' would mean to include the fee charged by the operator and also the Goods & Service Tax levies on the same. In market place models, the operator could earn his income either as a convenience fee from the customer (e.g. movie ticket bookings) or as a fulfilment or commission fee from the seller (e.g. online retail sales) or a combination of both.

In our view, the gross amount on which the tax would be deducted should not include the fee (convenience fee) separately charged by the operator to the customer.  The basis for this view is that the provisions provide for the tax on “gross amount of such sales or services or both” i.e. the word 'such' in the provision referring to the amount credited towards sale of goods or services to the account of the participant.

However, where a fulfilment or commission fee is charged by the operator to the seller, the gross amount paid by the customer could be inferred to include the operator's share of the income, since typically the operator reduces its fee and thereafter passes on the net amount to the seller.  This could result in a double incidence of tax on the same income since: (a) as a first incidence, the tax is deducted by the operator on the gross amount; and thereafter (b) as a second incidence, the participant is obligated to deduct tax on the amount of fulfilment or commission fee payable to the operator (under section 194 H).

3.3. In relation to the GST charged by the seller on its invoice to the customer, the phrase 'gross amount' of sales or services, could be construed as including the GST charged.  However, a view could be taken to exclude the GST charged from the purview of the tax deduction by, inter alia, relying on an administrative circular which clarifies that if the GST has been indicated separately in the invoice, no TDS would be required to be undertaken on such GST component.  Since the administrative circular deals only with services, it would be welcome if a specific clarification is provided by the CBDT to extend the benefit contained in this circular to goods as well and preclude the ambiguity.

4. Additional points to note

4.1. The TDS rate of 1% is increased to 5% where the participant does not furnish his PAN to the operator.

4.2. An individual or HUF whose sales do not exceed Rs. 5 lakhs, through the e-commerce operator, would be exempt from the TDS.  However, it is mandatory for these persons to furnish their Aadhar or PAN to such operator, else the threshold benefit would not apply.

For a participant that is a partnership firm, LLP or company, the TDS is undertaken without any threshold of / de minimis sales.

4.3. This provision would require the e-commerce operator to put in place processes to: (a) undertake TDS on all transactions where the sellers are partnership firms, LLPs and private limited companies; (b) track PAN and Aadhar of individual and HUF sellers on the electronic facility / platform; (c) track whether the sales of the individual and HUF sellers exceed Rs. 5 lakhs.

4.4. Similar to other withholding tax scenarios, a seller may also obtain a certificate for lower deduction of tax (under section 197 of the Act) from the tax authorities in accordance with the prescribed rules.

4.5. The manner in which compliance with these provisions is to be reported by way of quarterly e-TDS returns has not been presently provided for.  Clarifications in this regard are awaited.

4.6. Transactions which are subject to tax under this section will not be subject to tax deduction under other sections. It has been clarified that this exemption is not applicable in cases where the e-commerce operator receives revenue from advertisements and other services rendered which are not in connection with the sale of goods / provision of services. Such transactions are liable to TDS under the relevant sections.

4.7. On a related note, it is also proposed to introduce a tax collection at source (under section 206C) at 0.1% by a seller (whose total sales exceeds Rs. 10 crores in the financial year (FY) preceding the FY of the sale) from sales to a customer where such customer purchases any goods aggregating to more than Rs. 50 lakhs in a FY.  The rate of tax would be 1% where the buyer does not provide the seller with his PAN or Aadhar number.

4.8. In light of the definitions of 'e-commerce' and 'e-commerce participant', 'supply' of digital products through the e-commerce facility / platform would now be subject to the 1% TDS rate.  Hitherto, such 'supplies' were alleged to be payments for licenses and hence royalty, which mandated TDS at 10%.

4.9.  The proposed deduction of tax would apply to resident participants, whether or not:

· The consumer of goods or services is resident in India or outside India;

· The e-commerce operator is a resident in India or outside India.  This issue is particularly moot when the participant is resident of India since in such a case, the income of participant is taxable in India.  Here, in light of rulings which have affirmed the extra-territorial application of TDS provisions subject to an India nexus and the proposed amendment in this budget to section 204 to include non-resident or their agents under the purview of 'persons responsible for paying' the withholding taxes, the non-resident e-commerce operator would be required to comply with the TDS provisions in India.

The following table illustrates different types of e-commerce models and situations where the proposed section is applicable:

Sl. No	Operator	Model	Participant	Remarks
1	Indian resident   Examples: Cab aggregators, hotel aggregators and online retail platforms	Market place Model (MPM)	Indian resident   Examples: Sellers listed on retail platforms, service providers on aggregator websites.	Operator is liable to deduct taxes on the sale of goods / services facilitated on the platform
2	Indian resident   Examples: Travel booking sites	MPM	Non-resident   Examples: Hotels listed on the travel booking site that are located outside India.	Operator is not liable to deduct taxes as the participant is not a resident of India
3	Non-resident   Examples: Travel booking sites operated or owned or managed by non-residents	MPM	Indian resident   Examples: Hotels located in India which are listed on the travel booking site.	Operator is likely to be subject to this provision. A specific guidance from the Government on this aspect would be welcome.
4	Non-resident   Examples: Any website or platform owned/operated/managed by non-residents	MPM	Non-resident   Examples: Any seller registered / listed on such websites.	Operator is not liable to deduct taxes as the participant is not a resident of India

5. Has the legislator missed these perspectives? 

5.1. Scope of 'gross amount':  The provision proposes to have the operator deduct tax on the 'gross amount' of the sale or service provided by the participant. The phrase 'gross amount' is not defined and refers to the value charge by the participant to the customer.  The following would present interesting scenarios:

o  a product is sold through the e-commerce platform and the operator deducts appropriate taxes with respect to the amounts paid / credited to the seller.  Thereafter, the product is subsequently returned to the seller due to defects.  The proposals, as on date, do not provide any clarity on addressing such scenarios of reversals / returns.  

o e-commerce models could entail discounts or incentives to the customers before an amount is credited / paid to the participant.  There is presently no clarity on the manner in which 'gross amount' is to be construed in such a scenario.

An interesting observation here is that the proposal mentions that tax needs to be deducted by the operator at the time of credit to the account of the participant or at the time of payment to the participant, whichever is earlier. So if the operator holds back a portion of the funds in a “control” account (by introducing a contractual term to provide for a hold back amount to adjust for refunds or incentives) and does not credit to the specific participant account, can it be argued that the tax deduction is not due? Here it should be noted that unlike select withholding tax provisions in the Act, the proposal does not state a credit to a 'suspense account' or an account by any other name, in the books of account, such crediting shall be deemed to be credit of such amount to the account of the payee.

5.2. In addition to the above, the applicability of the section is to be examined in connection with operators who run their business adopting a combination of the marketplace / inventory based / listing model. For example, in the case of a hotel booking site which provides the options of booking its rooms in its own franchise of hotels (or has committed bookings) and also lists hotels of third-parties on its platform the following scenarios are likely to arise:

o  The operators i.e. the booking site is liable to deduct taxes on the bookings made by the customers for third-party hotel rooms;

o  The operators are not liable to deduct taxes on the bookings made by the customers for its own inventory of hotel rooms.

In such situations, it appears the operator would have to maintain separate records for the above-mentioned type of bookings for effective compliance with the provisions of section 194-O.

5.3. Impact on liquidity for e-commerce participants:  The proposal when implemented would have a significant impact on the cash flows of the e-commerce participants. Moreover, there appears, a distinction in the tax regime for an online model vis-à-vis the offline model of shop-in-shop. The following illustration depicts the layers of tax outflows on a sale of goods through an e-commerce operator as compared to an offline shop in shop model.

Particulars	E-commerce market-place model (Rs.)	Shop in Shop (offline) Model (Rs.)
Value of goods (Rs. 10,000)	10,000	10,000
GST @ 18% on goods	1,800	1,800
Customer Invoice	11,800	11,800
Amount collected by operator (on behalf of seller)	11,800	11,800
GST (TCS) by operator	100	0
Income Tax (TDS) by operator u/s 194-O	100	0
Less: GST on goods remitted by seller	1,800	1,800
Balance in seller's bank account	9,800	10,000

Note: The illustration does not consider the commission or rent earned by the intermediaries.

The margins of these e-commerce participants are typically known to be very low. Small entities could have done without the Government squeezing their already thin margins.  Specifically, since small players are likely to not have taxable profits to offset the TDS, claims of refunds from such e-commerce participants, especially the smaller players, can be expected to escalate.  To illustrate, press reports have cited senior personnel of the Retailers Association of India[2] (RAI) stating that most retailers operate with net profit margins of about 3% and the TDS obligation will result in 33% of the net income of retailers being blocked as TDS.

The Government could consider having the operators report (similar to an annual information return) the details of all the participants and their transactions. This could enable a monitoring of the income declared by the participants in their returns and assist in widening the tax net to include non-compliant participants. The current proposal appears to be riddled with concerns on liquidity squeeze and uncertainty on its scope.  In the current business environment was this necessary?

Disclaimer

The views expressed in this article are the personal views of the authors. The views / the analysis contained therein do not constitute a legal opinion and is not intended to be an advice.  For more details, we request you to write to: vishnu@sduca.com and dhanyanarasimha@sduca.com.  The authors acknowledge the significant contributions of Mr. B. G. Manjunath to the above article.

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Profit Attribution : From Arbitrariness to Agreement

1. Proposed amendment

One of the important provisions of the Finance Bill, 2020 is related to attribution of profits. Currently, Explanation 1(a) to section 9(1)(i) provides that in case of a business of which all the operations are not carried out in India, the income of the business deemed to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India.  

As per the proposals of the Finance Bill, 2020 the Advance Pricing Arrangement (APA) route as well Safe Harbour Rules (SHR) route would be available for determining the profits attributable to the operations in India for the purpose of section 9(1)(i) or specifying the manner in which such profits need to be determined.

The Finance Bill also simultaneously proposes amendment to Explanation 1(a) to section 9(1)(1) to remove profits attributable to activities involving Significant Economic Presence (SEP). Thus APA / SHR route would not be available for business profits related to SEP.

2. Application of APA / SHR - A welcome move to end the guess work!

The proposal could represent a huge shift from the current approach of arbitrary attribution followed by prolonged litigation to agreed attribution.

We did not have a proper answer to the issue of attribution[1] for almost 100 years now (or we never had) and the issue appeared to be getting addressed in an arbitrary manner in various forums. The following observations of the judicial authorities need to be noted:

The Bombay high court in the case of Blue Star Engineering Co. (Bombay) (P.) Ltd. v. CIT [1969] (BOM.)  [TS-5313-HC-1968(BOMBAY)-O] observed as follows:

We are not impressed by the said submission of Mr. Mehta. 2.5 per cent, no doubt, is some guess-work done by the Income-tax Officer, but substituting it by 10 per cent, again would be nothing more than indulging in further guesswork.

The Supreme Court in the case of Hukam Chand Mills Ltd. v. CIT [1976] (SC) / [TS-5010-SC-1976-O] observed:

In the absence of some statutory or other fixed formula, any finding on the question of proportion involves some element of guess work. The endeavour can only be to be approximate and there cannot in the very nature of things be great precision and exactness in the matter. As long as the proportion fixed by the Tribunal is based upon the relevant material, it should not be disturbed.

The review of certain recent judicial precedents may also suggest that the outcomes are still based on some high level presumptions or subjective or arbitrary judgments.

3. Problem of attribution and most desired approach

The real problem of attribution is determination of what proportion of profits should be attributed to specific functions in a business model involving cross border operations. In simple terms, if a business carried by a non-resident consist of four functions, two of which are performed in India and two outside India and if the non-resident earns profits of 100 from such business, how should this 100 be allocated? Should the profits be allocated to the functions in equal proportion i.e. 25 each? Or should the allocation by 30:30:20:20 or 50:10:25:15 or 25:10:15:50 or any other combination?

Ideally there should be some statutory guidance on this issue. It could be well within the sovereign taxing rights of a country to specifically provide profits attributed to the functions performed in its territory. One may want to argue that such specifications in the law could be arbitrary, but then that arbitrariness by the law appears to be fine as against leaving it to the discretion of the tax authorities or tax payers. Such arbitrary allocation rules will result in much desired certainty.

It can be observed that for certain types of cross border businesses, India has already exercised such sovereign rights and categorically specified the proportion of income / receipts subject to tax in India. This is the presumptive taxation regime in India represented by section 44B (shipping business -7.5%), section 44BB (exploration etc. of mineral oil - 10%), section 44BBA (operation of aircrafts - 5%) etc. These provisions specifically give the % of receipts which will be subjected to tax in India. If the profits for these businesses were to be determined in terms of Explanation (I)(a) to section 9(1)(i), it could have generated enormous amount of litigation.   

Proposed Rule 10 can also be said to be a step in the right direction as it also specifically provides guidance on proportion of income to be subjected to tax in India. However, the draft Rule 10 attracted significant criticism from the transfer pricing practitioners, rightly or wrongly. The draft Rule 10 continues to be a draft and CBDT may implement it after solution is found at a global level for taxation of digital economy. 

4. Can transfer pricing offer a complete solution to the problem of attribution?

The answer could be “yes” and “no”. Conceptually transfer pricing determines what is an arm's length price to a transaction? This essentially is the price at which independent parties would transact. This could be a subset of the problem of attribution as narrated in the preceding para. The manner in which changes are proposed in section 92CC appear to be supporting this assertion. The problem of attribution narrated in the preceding para does not arise as a result of involvement of related parties in a transaction, the problem arises as a result of performance of functions related to a business in different countries. In either case taxing rights of a sovereign cannot be determined or solely determined on the basis of the price at which independent parties transact. Such rights need to be specifically codified in the form of a law.

Thus transfer pricing cannot give complete solution to the problem of attribution. However, transfer pricing consist of well-established methods and application of such methods could give much better outcome as compared to arbitrary judgments.     

5. Does the Finance Bill proposal adopt transfer pricing as a solution to the problem of attribution?

Again the answer could be “yes” and “no”.  The Finance Bill proposal certainly brings the attribution issue within the scope of the framework used to get certainty on transfer pricing issues i.e. APA and SHR. However, at this stage it would be difficult to determine whether the attribution issue will be treated as transfer pricing issue and would be resolved in that manner.

Amendment to section 92CC(1) [especially clause (b)] may be seen as recognition of the fact that attribution issue u/s 9(1)(i) may not always involve international transaction or may not involve only international transaction. Specific reference to “the methods provided by rules made under this Act” in section 92CC(2) and corresponding changes to section 295 also support this.

Thus what get adopted from transfer pricing provisions is certainly the framework of APAs and SHR which leads to the desired certainty (due to upfront agreement between the parties). One will have to wait for corresponding changes in the SHR related rules and new rules in terms of section 295, to determine to what extent or if at all transfer pricing methods get adopted. It is also possible that the new rules draw some analogy from draft Rule 10 announced by CBDT (but not yet operationalised).     

6. Does proposed approach create any conflict with the tax treaties?

The proposed approach does not seem to be creating any conflict. The tax treaty distributes taxing rights in favour of the source country when a PE exists in the source country. The source country is authorised to tax the profits attributable to the PE and such profits are to be determined in terms of the provisions of the domestic law.

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Union Budget 2020- Panacea to India's economic slowdown?

With the Union Budget 2020, it seemed that the Hon'ble Finance Minister was determined to help India fight the “virus” of economic slowdown. There were expectations galore in the past few weeks, praying for some tax reforms and reliefs, such as roll back of capital gains tax on listed companies, abolishment of Dividend Distribution Tax (DDT), increase in personal tax exemptions, etc. Despite low corporate tax rates, the big guns of the industry expected further reforms that would smoothen the process of investment and restructuring activities in our country.

Walking on a tightrope of expectations, the Modi Government 2.0 announced the Union Budget 2020 with much required ardour. This article focuses on the key amendments to the Income-tax Act, 1961 ('the Act') introduced by the Budget, which would impact Mergers and Acquisitions (MnA) activities in India.

A.   Abolishment of DDT: The Finance Bill, 2020, provides that the provisions of section 115-O of the Act would be applicable only to those dividends that are declared, distributed or paid on or before 31 March 2020. This means that companies declaring or distributing dividends after 1 April 2020 no longer have to pay DDT. The relevant fallouts of this amendment are as follows. 

1.    Taxability in the hands of the shareholders: Any dividends received on or after 1 April 2020 will no longer be exempt. They will be subject to tax in the hands of the shareholders as per the applicable rates. Foreign investors will see the abolishment of DDT as a positive move, as they will now be eligible to obtain treaty benefits in relation to dividend income.

It is further proposed that the provisions with regard to withholding tax under section 194 of the Act would also be applicable and a company would be liable to withhold tax at the rate of 10% on dividends declared or paid. 

2.    Elimination of cascading effect: It is proposed to introduce a new section (section 80M) to provide reliefs with respect to inter-corporate dividends. It provides that when the total income of a domestic company (Co A) includes dividend received from another domestic company (Co B), a deduction of such amount (which is received by way of dividends) shall be allowed to Co A, which does not exceed the onward dividend distributed by Co A to its shareholders. However, to claim the said deduction, Co A needs to distribute the said dividend at least one month before the date of filing the return of income ('due date'). However, it is important to note that if Co A does not declare dividend by due date, the said dividend income may be treated as part of total income of Co A and hence be subject to corporate tax and MAT - depending upon the taxation regime adopted. Such deduction is available for dividends received from any domestic company and is not restricted to dividends received from only holding companies. This benefit is available even if one opts for tax under the new regime (lower tax rates as per section 115BAA/ 115BAB of the Act). 

While the Finance Minister has provided for elimination of the cascading effect with regard to dividends received from domestic companies, this has not been provided for dividends received from foreign companies. 

3.    Similar amendments are proposed for dividend distribution in the case of mutual funds.

4.    Business Trust (ReIT/InvIT): It is proposed to tax the dividend received in the hands of the unitholders - which was earlier exempt. It is worthwhile to note that earlier the SPV (which was entirely held by a business trust) was not liable to DDT. 

While this is a welcome move for many corporates who no longer have to pay additional tax on dividend, it creates a tax burden on non-corporate shareholders in whose hands this income was previously exempt or taxed at the minimum rate of 10%, as applicable. This is worrisome, especially for non-corporate shareholders who fall within the higher tax rate slab of 30%. Further, as companies would deduct TDS on dividend income, shareholders whose total income is less than the minimum taxable income will now have to file tax returns to claim the tax refund. In view of the aforesaid taxability, there may not be any disallowances under section 14A of the Act. 

B.    Land and Building related: Amendments are also proposed in section 43CA, section 50C and section 56(2)(x)(b) of the Act. These sections deal with deemed income with respect to transfer/ receipt of immovable properties being land or building or both. These sections provide that there would be no adjustment to the actual consideration values if the variance with the stamp duty value for the purposes of such transfer were less than 5%. This safe harbour limit has been extended to 10%.

Further, it is proposed to amend section 55 to provide that in an event of transfer of land or building or both, that is acquired before 1 April 2001, the deemed cost of acquisition cannot exceed the stamp duty value of such asset as on 1 April 2001. This eliminates the option of using the fair market value as on 1 April 2001 as the deemed cost. 

C.   Rationalisation of provisions of startups: To give further impetus to the startup industry and enable more startups to claim deduction under section 80-IAC of the Act, it is proposed to increase the maximum turnover limit from INR 250m to INR 1000m. Thus, any startup that does not cross the higher turnover limit of INR 1000m in any previous year, beginning from the year in which it is incorporated, shall be eligible to claim the deduction. It is also proposed to defer TDS or payment of taxes on perquisite value of the ESOPs of startups (which otherwise would have been payable on exercise of options by the employees) to a future date, thereby, eliminating the immediate cash flow problem arising on receiving the benefit in kind. 

As every year, this year too, the Budget had certain hits and misses. While the abolishment of DDT can prove to be a great hit amongst the corporates, the big guns may still be disappointed with some of the misses such as continuation of long-term capital gains tax on listed securities. However, given how the major tax reforms last year were made periodically, one may still hold on to their aspirations for the times to come.

[This article was co-authored by Falguni Shah (Partner) and Nidhi Mehta (Associate Director). The article includes inputs from Sneha Subramanian (Associate)]

Budget 2020 - Impact of key TP amendments

The Hon'ble Finance Minister presented the Union Budget 2020 (the Budget) on 1 February 2020. The Government came out with various tax proposals to reduce taxation burden, simplify compliance, reduce litigation, enhance transparency and safeguard taxpayer rights, with a view to enhance investor confidence and increase the ease of doing business in India. In this article we discuss various proposals made on the Transfer Pricing (TP) front.

Determination of income attributable to a permanent establishment (PE) in India

The issue of income attributable to a PE of a non-resident in India has been a bone of contention between the taxpayer and Indian Tax Authorities (ITA) for long. Taxpayers have been arguing that the application of arm's length principle results in the correct determination of profits attributable to a PE, based on the harmonious reading of the provisions under the Act and Double Taxation Avoidance Agreements. However, the ITA have been using various formulaic or arbitrary approaches under the garb of powers provided by Rule 10 of the Income Tax Rules, 1962 ('the Rules') to compute such profits. This coupled with the divergent positions adopted by the Indian judiciary in various cases has resulted in lack of clarity on the approach to be adopted for such attribution purposes.

While the tax taxpayers may still need to litigate whether or not a PE exists in India, the Indian Government has attempted to reduce litigation on the attribution matters by extending the benefit of Safe Harbour Rules (SHR) for carrying out such income attribution exercises. Furthermore, it has been clearly provided that an Advance Pricing Agreement (APA) route may also be taken for such cases.

SHR and APA provisions were introduced in India in order to reduce TP litigation. The SHR assured acceptance of the transaction value declared by the taxpayer by the ITA, if such price was computed as per prescribed rules. Similarly, APA provided an avenue to agree the arm's length price (ALP) or manner of determining the ALP of international transactions with the ITA.

In order to help the taxpayers in avoiding litigation and attain certainty on attribution matters, the Indian Government has proposed that from Financial Year (FY) 2019-20 onwards, the taxpayers can opt for SHR to determine the income attributable to a PE in India. Furthermore, clarity has been provided on the option available to the taxpayer to use the APA route for determining income or the manner of determining the income attributable to a PE, wherein:

·         Said option will be applicable for APAs entered on or after 1st April 2020; and

·         Option of rollback for covering past four years will also be available.

While the APA FAQs released by the Indian Government clearly mentioned that a taxpayer admitting to existence of PE in India can opt for APA to determine the profits attributable to a PE in India, the above proposal in the budget further reinforces this position.

The taxpayers will need to be cautious while evaluating whether to go for SHR or APA for attaining certainty on the attribution matters.

Opting for SHR will provide certainty to taxpayers by computing profits based on the prescribed formula/ methodology/ pricing, which will be notified by the Government in future. This option will help taxpayers in saving time, as they may simply compute income using the approach provided by the Government. However, in order to ensure that this option is well received by the industry, the Government needs to ensure adoption of a practical approach while framing the detailed rules.

On the other hand, APA requires a taxpayer to engage in detailed discussions with the APA team. This requires significant investment in terms of time to prepare robust documentation for submission, making presentations and negotiating with the APA team. However, it will also provide the taxpayer with an opportunity to discuss case specific facts before agreeing on income attributable or attribution methodology.

It is needless to say that the above proposals will go a long way in reducing litigation in India. Furthermore, it will also help the Indian Government in endorsing its flagship APA programme and building on its past success story on this front to win taxpayer confidence.

Rationalisation of Dispute Resolution Panel (DRP) provisions

The current DRP provisions, as provided u/s 144C of the Act, requires an assessing officer (AO) to forward a draft assessment order to the eligible assessee in case of any variation proposed in the income or loss returned which is prejudicial to the interest of the eligible assessee.

While the DRP mechanism helped in fast-tracking dispute resolution, it was observed that prejudicial directions were often issued by the AO during the course of assessment, either in respect of corporate tax matters or based on the order of Transfer Pricing Officer (TPO), which although did not result in any variation in the returned income or loss, were still prejudicial to the interest of the taxpayer. In view of the same, it has been proposed in the Budget to omit the words “income or loss returned” so as to provide the taxpayers with an opportunity to approach the DRP even for such prejudicial observations made by the AO/ TPO.

The application of this provision can be understood through a simple example - Co. A is an Indian Company, which operates as a captive software developer for its parent Co. B, a resident of USA. During the course of assessment, the TPO does not disturb the ALP of the software development services provided by Co. A to Co. B. However, the TPO re-characterises d the software development services to contract R&D services. Under the existing regime, the AO is not bound to issue a draft order to Co. A, as there is no variation in the returned income or loss. However, with the proposed amendment, AO will have to issue a draft order in this case and Co. A will be able to approach the DRP to challenge such recharacterisation of its services.

In addition to the above, the benefit of the DRP provisions is proposed to be extended to a non-resident, not being a company, by amending the definition of eligible assessee. Presently, DRP route was restricted to cases where variation arose as a result of order of the TPO or in case of a foreign company. By amending the definition of eligible assessee, the Budget proposes to provide a big relief to non-corporate non-residents, who can now access the faster DRP route.

Relaxation in the interest deductibility rules

In order to tackle the tax challenges posed by excessive use of debt financing, OECD as a part of BEPS Action Plan 4 had recommended that countries may adopt interest limitation rules, in order to put restrictions on the deductibility of such interest while computing taxable income of an entity.

In line with the above, Finance Act 2017 inserted section 94B in the Act to provide a cap on the interest deductibility in certain cases. The said section restricted deductibility of excessive interest paid by an Indian company or a PE of a foreign company in India on debt taken from a non-resident associated enterprise (AE) while computing the taxable income of such person.

The existing definition of AE provided under section 92A of the Act deems two enterprises to be AEs if loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one per cent of the book value of the total assets of the other enterprise. Consequently, interest paid to an Indian PE of a non-resident person, engaged in the business of banking, also got disallowed, where such PE met the above AE threshold, since such PE has a non-residential status for tax purposes. Accordingly, based on representations received from various stakeholders, it has been proposed in the Budget to provide relief from interest limitation rules in the above case from FY 2020-21 onwards.

Change in due date for furnishing Form No. 3CEB and maintenance of TP documentation

Under the existing provisions, any person entering into an international transaction or specified domestic transaction during a previous year is required to prepare TP documentation (subject to some threshold) and furnish Accountant's Report (AR) in Form No. 3CEB on or before the date specified. Presently, such specified date was 30th November of the assessment year. It has been proposed in the Budget to revise the said due date to 31st October of the assessment year. Such revision shall be applicable from FY 2019-20 onwards.

Considering the reduction in timelines, the taxpayers would need to gear up and adopt a proactive approach during the upcoming compliance cycle to ensure timely preparation of contemporaneous TP documentation as well as filing of Form No. 3CEB.

New penalty provisions

The Budget has proposed a new penalty provision through insertion of section 271AAD of the Act. The said provision proposes a penalty equal to the aggregate amount of false entry or omitted entry in the books of accounts, where such entry is made or omitted to evade tax. Such penalty will apply on the person maintaining such books of accounts as well as on any person who causes the first mentioned person in any manner to make a false entry or omits or causes to omit any such entry.

Among other things, the term 'false entry' includes use or intention to use an invoice in respect of supply or receipt of goods or services or both issued by the person or any other person without actual supply or receipt of such goods.

The implications of the newly inserted penal provisions need to be analysed on outbound intra-group payments. Such payments have been historically subjected to extensive scrutiny by the ITA on the ground of non-receipt of actual services from overseas group company. It would be interesting to see if the proposed penalty further aggravates the plight of taxpayers.

The Indian Government has proposed some interesting changes in the TP provisions in this Budget. With an aim to bring down litigation and enhance ease of doing business in India, the government has made amendments in respect of SHR, APA and DRP provisions. While the above proposals are likely to help in developing a positive sentiment amongst the stakeholders, few changes which were expected on the TP front, such as rationalisation of master file thresholds and timelines and alignment of arm's length range to globally followed inter-quartile range, were not touched upon in this Budget. It can be expected that the Indian Government may separately come out with suitable amendments in the Rules to address these areas.

(With inputs from Varun Gupta and Vinay Aggarwal, Chartered Accountants)

Dividend taxation - Fictitious Boon

Background

Dividend taxation has always been a contentious issue in India. India has adopted a unique system of taxing dividends. The distributing company pays tax, and not the recipient (this is the Dividend Distribution Tax - 'DDT'). Also, this isn't a withholding tax (commonly referred to as TDS) but rather, a final tax. The effective rate of dividend is very high and there are only a few exemptions. This also leads to a cascading impact - i.e. a case of paying DDT multiple times on the same income.

The Finance Bill, 2020 has proposed to remove DDT. Besides that, there are certain exemptions proposed. As per the FM's speech, these changes 'increase the attractiveness of the Indian equity market and will provide relief to a large class of investors'. The estimated revenue foregone under these measures is a whopping 25,000 crores. It is difficult to understand how there will be such a huge deficit, since in most cases the tax burden will increase, even substantially in some cases.

The complicated present system of dividend taxation

Before we move onto the amendment, let us examine the complications involved in the current system of taxation. This will help understand the proposed changes better:

1.       DDT is a tax imposed on the company distributing profits. The company pays tax for the shareholder's income.

§  Non-residents can claim international tax-treaty benefit on Indian-sourced income. However, since this is a tax imposed on the company and not the shareholders, it is not possible for them to claim such a relief.

§  Further, the home country of the non-resident shareholder may not allow credit for tax paid in India, since such tax is paid by the company and not by the shareholder itself - even though the tax is imposed in the shareholder's income.

Note that currently, it is possible to take an argument that the reduced rate for dividend in the treaty will apply in case of DDT as well. This may be examined to claim benefit of the reduced rate for dividend already declared.

2.       Dividend is further taxed in the hands of a non-corporate shareholder at the rate of 10% who is a tax resident of India, in case the dividend income exceeds 10 lacs (section 115BBDA).

§  The rate of 10% is subject to surcharge ranging from 0% to 37%.

Proposed change

It has been proposed that DDT will not be applicable on dividend declared post 1-4-2020. Dividend will be taxable under Section 57 of the Act under the normal rates applicable to the recipient.

Participation exemption (existing provisions)

Most of the countries in the world exempt dividend received by a company from another company to ensure that the same dividend doesn't suffer multiple tax. This is known as participation exemption. India has similar provisions but the same is riddled with superfluous conditions. Some of the provisions are as follows:

Holding company - subsidiary company

Dividend from a subsidiary company to a holding company is subject to DDT. However, if the holding company declares dividend, it doesn't have to pay DDT again.

1.       The dividend must be distributed in the same year. If the dividend distribution is deferred, DDT will be imposed again.

2.       Dividend received by an Indian company from a foreign company is subject to a tax of 17.5%. Onward distribution is exempt from DDT if distribution takes place in the same year.

Company holding less than 50% in another company

In this case, cascading impact cannot be avoided. DDT will be payable at each and every level of dividend declaration.

Dividend received by an Indian company from a foreign company is subject to 17.5% tax, only if the holding exceeds 26%. If it has a holding of less than 25%, tax at the normal slab rate will apply (25%, 29%, 34%, etc.). Further distribution of dividend by the Indian company results in further DDT imposition.

It can be seen above that the current provisions of participation exemption is complex and restrictive.

Participation exemption (proposed provisions)

It is proposed that any dividend received by a domestic company from another domestic company will be allowed as deduction in the hands of the domestic company. The conditions for exemption are as follows:

1.       Distributing and receiving company should be domestic companies - hence, this is not applicable in case of dividend received from or by a foreign company.

2.       The company receiving dividend should further declare dividend in the same year, upto 1 month before the return filing due date - generally 30th September or 31st October.

3.       The amount of such deduction will be limited to the amount further distributed as dividend by the receiving company.

This will certainly simplify the current provisions - especially in case of multiple level of companies and where the stake involved is 50% or less.

However, dividend received from a foreign company will continue being taxed under the current provisions. Similarly, dividend paid to a foreign company will be taxed in the hands of the foreign company.

Expense deduction

As per the current provisions, there is no question of allowing deduction of expenses, since dividend income is exempt. Even if it is taxable at 10%, the tax liability is on gross basis, i.e. without allowing any deduction.

Due to the change proposed, deduction of expenses will be important. In certain cases, like Mutual Funds registered under SEBI or set up by public sector banks/financial institutions, etc. it has been provided that only interest expense will be allowed as a deduction. Further, such interest expense will be restricted to 20% of the dividend income. It is interesting to note that even though only restricted expenses are allowed, the same will not suffer a disallowance since the ultimate income (dividend) will not be exempt. It may be possible to claim such expenses against business income.

Disallowance of expense incurred for earning exempt income

Presently, expense incurred for earning exempt income is disallowed under Section 14A. This has led to several litigations and is a common problem faced when dividend income is involved.

Due to the changes proposed, dividend will no longer be exempt. In that case, there won't be a question of disallowing the expenses. Even in case of dividend declared by one domestic company to another, even though the same is exempt from tax through a deduction from total income, the issue of expense disallowance won't arise.

Withholding Tax / TDS implications

TDS at the rate of 10% will be applicable on dividend distributed to resident shareholders subject to a small threshold. In case the recipient is a non-resident shareholder, TDS will generally be applicable on the actual rate of tax for the non-resident. In this case, things like tax residency certificate, PAN, tax treaty, etc. will impact the final rate of tax.

This may lead to an extremely cumbersome process for a listed company having many non-resident shareholders. The application of this provision will be a big challenge.

Impact analysis

Case 1 Domestic company having Indian Resident individual shareholder

Dividend declaration  by a domestic company to an Indian individual shareholder will lead to a substantial increase in the tax burden, as follows:

Particulars	Existing	Proposed
Profits distributed	121	121
DDT for company	21	-
Dividend received	100	121
DT for individual	14	52*
Net receipt	86	69
Net Tax	35	52
Total tax as a % of profits distributed	29%	43%

*this is for an individual earning income more than 5 crores. Overall tax at different income levels will be as follows:

Income		Total tax (%)
2 to 5 crores		39%
1 to 2 crores		36%
0.5 to 1 crore		34%
10 to 50 lacs		31%

In case where a domestic company declares dividend to an Indian resident, the same is taxable at 17.05% to 29% depending upon the amount of dividend. Based on the proposed changes, the tax rate will be much higher and can go upto 43%. Here, we have considered the overall tax, i.e. the DDT plus the Dividend Tax (DT) paid by shareholders. It is to be noted that as per the proposed provisions, the actual tax rate will reduce on account of claiming expenditure on earning the same.

 

Case 1A Domestic company having Indian non-corporate non-individual resident shareholder 

Particulars	Existing	Proposed
Profits distributed	121	121
DDT for company	21	-
Dividend received	100	121
DT for firm/LLP	14	42
Net receipt	86	78
Net Tax	35	42
Total tax as a % of profits distributed	29%	35%

 

The overall tax burden can be significantly reduced (from 43% to 35%) in case the shares of a company are held by a firm or an LLP.

Case 2 Holding companies - ICo1 holding shares of ICo2 (no onward distribution) 

In certain cases, promoters decide to hold their shares via a investment company. Generally, since such an investment company is wholly owned by that individual or their family members, there is no further outflow of dividend. In such a case, the tax implications will be as follows: 

Particulars	Old regime	New regime
Profits distributed by ICo1	121	121
DDT paid by ICo1	21	0
Dividend received by ICo2	100	121
Tax on receipt paid by ICo2	NA	30
Net receipt	100	90
Net Tax	21	30
Total tax as a % of dividend declared by A Co.	17%	25%

The tax implications will increase from 17% to 25%. However, it is possible to claim expenses under the proposed provisions.

 

Case 3 Overseas investment from India

In this case, under the Existing, there are multiple possibilities depending upon the shareholding in the foreign company. Based on that, the tax rates will be as follows:

Shareholding in FCo -	Existing	Proposed
> 50%	29%	53%
26 to 50%	41%	53%
< 26%	50%	53%

 

It is clear that even though the proposed system simplifies the dividend taxation, it has increased the burden on the already burdensome system.

Case 4 FDI - Foreign investment in India

One of the goals of removing DDT was to reduce the burden for foreign investors. As can be seen in the following table, the tax liability for a foreign shareholder will be considerably reduced. 

Particulars	Old regime	New regime
Profits distributed by ICo (100% distribution)	121	121
DDT paid by ICo	21	0
Dividend received by FCo (again 100% distribution)	100	121
Tax on receipt paid by FCo (WHT)	NA	12
Amount received by FCo shareholders	100	108
Tax on dividend income*	20	12
Net receipt	80	96
Net Tax	41	24
Total tax as a % of dividend declared by A Co.	34%	20%

*20% tax on dividend in FCo country assumed; Also, it is assumed that DDT will not be allowed as a credit

Points to be noted

Buyback

Buyback of shares continue being taxed in the same manner. Tax on buyback is 23% of the profits distributed. This will not be regarded as capital gains and no benefit of indexation or investment in eligible securities will be allowed.

Non-resident taxation

For non-residents, certain documents like Permanent Account Number and Tax Residency Certificate are required to claim a lower tax rate. In absence of these documents, there is a possibility of a higher withholding tax burden. Further, for non-resident entities, it is important to ensure that the Place of Effective Management is outside India. Further, the anti-abuse conditions like beneficial ownership, principal purpose test, limitation of benefit provisions, GAAR, etc. needs to be satisfied for a beneficial treaty rate.

Indian shareholders

Indian shareholders are likely to be burdened with a high tax rate. This is true even for individuals having income greater than 10 lacs, and especially important for higher income levels. It becomes pertinent for such shareholders to re-evaluate the entity status, holding entity, dividend repatriation model, etc. to ensure optimisation of tax.

Tax efficient restructuring opportunities

Under the current system, there is a possibility of claiming the beneficial rate of the treaty to reduce the DDT rate. The same should be examined for dividend paid in past, in order to claim a refund.

It is possible for Indian promoters to evaluate the following, and optimise tax on repatriation -

-          Repatriation strategy - there are different ways of extracting profits from a company

-          Entity - LLP v. company should be examined; dividend tax is not applicable in case of LLPs

-          Holding entity - Instead of holding shares directly, shares can be held by a firm or an LLP

There are many strategies which can be evaluated for reducing the tax burden - for Indian promoters as well as for foreign investors. This becomes crucial considering the increasing burden on the personal taxation.

Conclusion

Abolition of DDT will lead to an extremely high tax burden on the domestic players. This will more than reverse the temporary boost that was given to the economy due to the tax rate cuts. The government has been playing with the dividend taxation since a long time and presently, it seems to be at the worst possible level for Indians.

Overseas investors will certainly get a relief. However, such relief will be subject to a lot of things which are involved in application of a treaty - documents, compliances as well as fulfilling the anti-abuse provisions, which seems to be continuously changing globally.

Listed companies may have a tough time in carrying out the compliances w.r.t. withholding taxation - as it stands now, separate compliance will be required for almost each and every non-resident shareholder.

Looking at the complications and the burden involved, it would make sense to relook the provisions. This can be done by simple measures like capping the maximum rate of charging dividends, liberalising the participation exemption regime, etc.

[The article is co-authored by Suril Mehta (Associate Director, K.C.Mehta & Co), Sanjana Shah (Assistant Manager) and Shaan Shah]

Budget 2020 - Banking Sector - Hits & Misses!

The Scenario of the banking industry this year as per the Economic Survey for FY 2019-20

The credit growth in the economy has been declining since the beginning of 2019-20. Bank Credit growth (YoY) moderated from 12.9% in April 2019 to 7.1% as on 20 December 2019, due to sharp deceleration in credit growth to the services sector. Negative growth of credit to Micro, Small and Medium Enterprises and Textiles has contributed to slow down in credit growth to industry. 

The Gross Non-Performing Advances (GNPA) ratio of Scheduled Commercial Banks (SCBs) remained flat at 9.3 per cent at the end of September 2019, as was at end March 2019, whereas their restructured standard advances (RSA) ratio remained unchanged at 0.4% during the said period. The Stressed Advances (SA) ratio of SCBs remained flat at 9.7 per cent as at end-September 2019. 

The GNPA ratio of Public Sector Banks (PSBs) was unchanged at 12.3 per cent while stressed advances ratios increased from 12.7 per cent at end March 2019 to 12.9 per cent at end September 2019. 

Capital to risk-weighted asset ratio (CRAR) of SCBs increased from 14.3 per cent to 15.1 per cent between March 2019 and September 2019, largely due to improvement in CRAR of PSBs. 

Major Policy Initiatives Announced in the Budget 

Budget Outlays for the financial sector is as under: (Rs. In crores) 

Sr. No	Sector Name	BE-19-20	RE-19-20	BE- 20-21
1	Banking, Insurance, Financial Markets and Infra Finance	19,002	23,686	40,433

Capital Infusion in public sector banks was to the extent of Rs 80,000 crores in FY 2017-18 and Rs 106,000 crores in 2018-19. In the current financial year Rs 64,612 crores has been infused as capital out of provision of Rs.70,000 crores. 

·         Deposit Insurance Coverage to increase from Rs.1,00,000 to Rs.5,00,000 per depositor.

·         Proposal to sell balance holding of government in IDBI Bank to private, retail and institutional investors through the stock exchange for greater private capital.

·         The Government intends to introduce major reforms in recruitment to Non-Gazetted posts in government and public sector banks.

·         Governance reforms would be carried out in the 10 banks that are being consolidated into 4 banks wherein the Government has infused Rs 350,000 crores, so that they become more competitive. A few among them will be encouraged to approach capital market to raise additional capital.

·         To strengthen the co-operative Banks, amendments to the Banking Regulation Act are proposed for increasing professionalism, enabling access to capital and improving governance and oversight for sound banking through the RBI.

·         Appropriate measures to be taken to bring in transparency and greater professionalism in Public Sector Banks.

·         With a view to resolve working capital credit issue for the MSMEs, it is proposed to introduce a scheme to provide subordinate debt by Banks for entrepreneurs of MSMEs.

·         EXIM Bank together with SIDBI to provide handholding to mid sized companies for the expiort markets in selected sectors such as pharmaceuticals, auto components and others, 

The Union Budget 2020 was presented on February 1, 2020 and it was expected that Government may provide some relief to Banks with respect to soaring NPA's. 

Major tax reforms proposed in the Finance Bill 2020 relevant to banking 

·         Limitation on interest expenditure for borrowing from non-resident AE under section 94B of the Act is proposed to be amend to exclude interest paid in respect of debt issued by a Permanent Establishment (PE) of a non-resident Bank. This amendment is effective from assessment year 2021-22.  

 

·         It is proposed to amend section 72AA of the Act, to allow carry forward of accumulated losses or unabsorbed depreciation of the amalgamating banking company in the hands of the amalgamated banking company in the case of amalgamation of one or more corresponding new bank or banks with any other corresponding new bank under a scheme brought into force by the Central Government under section 9 of Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 or under section 9 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 or both. This is applicable from AY 2020-21. 

·         Section 206C has been proposed to be amended to provide that an authorised dealer, receiving an amount of seven lakh rupees or more in a financial year for remittance out of India under the Liberalised Remittance Scheme of RBI, shall be liable to collect TCS at the rate of 5%. Further, in non-PAN / Aadhaar cases, the TCS rate shall be 10%. The amendment is effective from 1 April 2020. 

·         Section 92CB (empowering CBDT to make safe harbor rules for determination of arm's length price (ALP)) and 92CC (empowering CBDT to enter into an advance pricing agreement (APA) with any person) have been proposed to be amended to include the determination of attribution of profits to a Permanent Establishment of a non-resident. The amendment to section 92CB shall be applicable from AY 2020-21 and section 92CC shall apply to an APA entered into on or after 1 April 2020.   

·         Concessional rate of TDS of 5% on interest in respect of monies borrowed by an Indian company from a source outside India which is currently applicable only for borrowings before 1 July 2020 has been proposed to be extended to borrowings before 1 July 2023 (Section 194LC). 

·         TDS of 4% is proposed to be applicable, on interest payable to a non-resident, in respect of moneys borrowed in foreign currency from source outside India, by way of issue of long-term bond or Rupee denominated bonds (RDB) on or after 1 April 2020 but before 1 July 2023 and which is listed on recognized stock exchange located in International Financial Service Center (IFSC).  There are 40 banking entities in the International Financial Services Centre (IFSC) Gift city. 

·         Section 194J to be amended to provide for a reduced rate of TDS of 2% as against 10% on payment to a resident by way of fees for technical services. Rate of TDS in other cases continue to remain at 10%.

·         It is proposed to charge Commodity Transaction Tax (CTT) on new commodity derivative products like sale of a commodity derivative based on prices or indices of prices of commodity derivatives, sale of an option in goods, where option is exercised resulting in actual delivery of goods and sale of option in goods, where option is exercised resulting in settlement otherwise than by actual delivery of goods. This is applicable w.e.f. 1 April 2020. 

·         No dividend distribution tax (DDT) shall be payable by the Company on dividend declared, distributed or paid on or after 1 April 2020. Consequently, dividend income shall be taxable in the hands of the shareholder effective from AY 2021-22 and tax shall be deducted at source therefrom. 

Tax changes expected 

Considering the large NPA situation and the economic conditions, banks were expecting much more changes and reliefs in income-tax, some of which are:

i)     Increase in the prescribed limit for deduction under section 36(1)(viia) considering the significant amount of NPAs. Currently, Banks and Financial Institutions are allowed deduction Provisions for NPAs subject to limit of 5%/7.5%/10% of Adjusted Total Income.

ii)    In computation of MAT for Banks, Provision for Bad and doubtful debts should not be added back as “the amount set aside as provision for diminution in the value of any asset”. This is because, while computing taxable income under normal provision, deduction in respect of provision for bad debts is allowed subject to the certain limits. 

iii)   The Indian Banks can now opt for reduced corporate tax rate of 25.17% inclusive of surcharge (10%) and cess (4%) whereas foreign banks having branches in India have to pay tax at the tax rate of 43.68% inclusive of surcharge (5%) and cess (4%). Also, DDT has been removed. Thus, there is huge disparity between the rates of tax applicable to domestic banks and foreign banks. 

iv)   Section 269SU which requires every person carrying on business having total turnover exceeding Rs.50 crore, to provide the facility for accepting payments through prescribed electronic modes like BHIM UPI, UPI-QR Code and debit cards powered by RuPay to accelerate a cashless economy. The Banks have been already following the RBI prescribed modes for payment systems and therefore the above requirement should not apply to banks. 

[The article is co-authored by Alifya Hakim (Director) and Vidya Mallya (Senior Manager) with Deloitte Haskins and Sells LLP]

Inclusion of PE profit attribution in APA, Safe Harbour scope - A welcome move!

Finance Bill 2020 in a welcome move has proposed to include determination of profit attribution to PE as part of Safe Harbour Rules (SHR) and Advanced Pricing Agreement (APA) regime in India. APA in particular has been well received and has attracted considerable popularity with MNEs as an effective dispute resolution mechanism. CBDT has successfully signed a number of APAs on a variety of inter-company transactions effectively resolving Transfer Pricing disputes in India. 

Attribution of profits to PEs has been a subject matter of litigation before the Indian Courts / Tribunal, with different approaches adopted of determining profits to PE. Depending upon the facts and circumstances of specific cases, Courts have adopted various approaches of determining attribution to PE such as ad-hoc attribution, attribution based on FAR analysis, formulary apportionment etc.   

Tax authorities so far have been trying to keep attribution of profit to PE separate from the determination of arm's length price (ALP) under APA. Till date, the tax authorities' stance has been that, APA programme is only meant for transfer pricing related issues and attribution of profits to a PE is not specifically covered by the APA programme. This resulted in exposure of additional profit attribution to PE in India even after the detailed scrutiny and agreement on the ALP under APA. 

As per the explanatory memorandum to Finance Bill 2020, Government did receive representations that the disputes on attribution of profits to the PE of a non-resident could be avoided / resolved effectively within the framework of APA and safe harbour mechanism. Accordingly, in order to provide tax certainty to the taxpayers, Finance Bill 2020, has proposed to bring attribution of profits to PE within the ambit of safe Harbour and APA by making specific provision under the Income Tax Act.  

This is timely in view of the recent developments both in India as well as globally where profit attribution is being hotly debated as under:  

·         CBDT had released a draft discussion report in April 2019 on the attribution of profits to the PE of non-resident enterprise in India. The discussion draft recommended the use of the fractional apportionment method for profit attribution i.e. a formula-driven methodology for profit attribution in India that gives equal weight to three factors- Sales, Manpower (employees and wages); and Assets. Further, the discussion draft also suggests the inclusion of a fourth factor (users) in the formula in the case of digital businesses, in light of the “significant economic presence” concept legislated by India for digital businesses.  

·         In terms of international development, the OECD as part of its on-going work on digital economy is exploring several approaches on a 'without prejudice basis' as presented in the Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy. As part of the work, OECD has proposed, to the extent that highly digitalized businesses are able to operate remotely and/or are highly profitable, all proposals would reallocate taxing rights in favour market / user jurisdictions and focuses on the concurrent revision of allocation and nexus rules. It intends to go beyond the arm's-length principle and new nexus rules that would not depend on physical presence in the user / market jurisdiction 

The above on-going developments are likely to create uncertainties for MNEs in view of emerging views of the Indian tax authorities as well as of the OECD on the subject. By brining attribution of profit to PE particularly as part of the APA and SHR regime will bring in much needed certainty to taxpayers. 

Globally, there are international jurisdictions (e.g.: UK, Australia) which appropriately cover PE profit attribution as part of its APA program.  

The proposed inclusion of profit attribution to PE within the scope of Safe Harbour and APA is a step in the right direction considering the highly litigious nature of the issue as aforementioned. However, it is pertinent to note that the experience and proficiency of the relevant APA authorities as well as availability of sufficient APA teams will play a critical role to have the desired impact. It will be imperative for the taxpayers as well as the APA authorities to understand the nuances in relation to the complicated subject under consideration for achieving the intended outcome. 

[The article is co-authored by Nikhil Dharival (Director, Deloitte Haskins & Sells LLP)]

Relaxation to Foreign Companies earning Royalty or Fees for Technical Services from Filing Tax Returns in India

The Finance Minister in the Budget Speech emphasised on reducing the tax burden in India and boosting India as an attractive destination for foreign investments. For this several measures are undertaken such as incentives to start ups, lower/incentive tax rates for domestic companies, single window clearance, ease of doing business in India etc.

For reducing the tax compliances for foreign companies in India, it is proposed that the foreign companies earning Royalty or Fees for Technical Services (FTS) from the Indian Company are not required to file tax returns in India if the said income is subject to tax in India which is not lower than the tax stated in the specified provision i.e. Section 115A of the domestic Act.

Some years back there was always a myth as to whether the foreign companies are required to file tax returns in India when appropriate taxes are withheld in India. Although there was exemption in the Act for interest and dividend income, similar exemption was not available for the royalty or FTS income. The proposal of exempting foreign company earning royalty or FTS income for filing tax return in India is a welcome provision and a big relief to the foreign companies in reducing their tax compliances in India relating to filing of tax returns and transfer pricing report.  

However, the exemption will be available only for the Royalty or FTS income taxed under the domestic Act and not under the Double Tax Avoidance Tax Treaty. In the following situations the exemption from filing tax return may not be available:

§  Where the taxes are not withheld basis relying on the Treaty provisions:

Under the Domestic Act, an obligation is cast on the payer to withhold tax at source while making payment to a foreign company if the income is taxable in India. Foreign company is eligible to claim the benefit of the beneficial provision of the Act or the relevant double tax treaty.   If the payer has applied the beneficial provision of the tax treaty and has not withheld the tax at source then as the said income is not taxed in India, there will be no exemption from filing of the tax returns in India.

 

For instance, the Indian company is making payment of FTS to a Foreign Company in Singapore. The said income is taxable under the domestic tax provision. However, under the Double Tax Treaty between India and Singapore the said income can be taxable only if it “makes available” technical knowledge or skill or know how to the Indian Company. Assuming the make available condition is not satisfied and therefore the Indian payer has not withheld the tax at source.

 

Similarly, there could be some Tax Treaties where there is no FTS clause for instance UAE country. In such case, although the income under the domestic Act is taxable as  Royalty or FTS, it may qualify as business income under the Tax Treaty in the absence of FTS clause and accordingly may not be taxable in India unless the foreign company has a permanent establishment in India.

 

In above  cases since no tax is withheld in India, the exemption from filing of the tax return in India will not be available even if the income is not taxable under the relevant Tax Treaty as FTS.   

§  Where the Foreign Companies/ Payer have obtained Ruling from Authority for Advance Rulings (AAR)- Income is not taxable in India. 

The proposed provision exempts foreign company from filing tax returns in India if the appropriate taxes are withheld. Under the domestic Act, there are provisions where the Foreign Company or the Indian payer can approach the AAR and obtain a ruling on the taxability of the proposed transaction in India. If the AAR has ruled that the income of royalty or FTS is taxable under the Act but not under the Treaty, then the said income shall not be subject to tax in India. In such case, even though the income is not taxable in the hands of the foreign company, they may be required to file tax return in India as there was no taxes withheld on the said income.

In addition to above, there may be certain instances as well where the Foreign company need to consider filing the tax return in India even though the taxes are withheld under the Domestic Act

§  Where the Tax is withheld - More than the specified Tax Rate [cases where foreign company does not have Permanent Account Number (PAN) in India] 

Under the Domestic Act if the foreign company is not having a PAN in India, it is subject to higher withholding tax rate of 20% as compared to the tax rate of 10% applicable on royalty or FTS income. Although the Government has liberalised, and the higher tax rate is not applicable to the Company not having PAN provided they furnish the specified documents. If the Company has not provided documentation and the income is subject to tax @20%, in such cases, the Foreign company may need to analyse filing of the tax return depending upon the quantum of transaction and claim the refund of additional tax of 10%. 

§  Where the Tax is deducted but the Foreign company wants to adopt a position different from the position adopted by the payer while withholding tax at source 

Under the Domestic Act, there are stringent provisions imposed on the payer who has defaulted in deducting tax such as denial of corporate tax deduction of the expenses, considered as assessee in default and subject to tax, interest and penalty. The payer while making payment to foreign company is required to ascertain if the income is taxable in India and subject to withholding tax. Also, for various payments like payment for reallocation cost, recharge of salary cost, payment relating to software, reimbursement of expenses etc there are mixed judicial rulings and therefore the payer may have adopted a conservative approach and withhold tax while making payment to the foreign company. However, if the foreign company is of the view that the income is not taxable in India, then they can adopt a different position in the tax return and claim the refund of taxes paid in India. As such, even if the income is subject to tax in India and the exemption is available for not filing the tax return in India, the foreign company may need to consider whether they want to file the tax return and claim the refund of taxes withheld especially when they may not be able to utilise the credit of taxes withheld in India in their country of residence 

The proposal of foreign company being exempt from filing tax return in India is a welcome move, however restricting the exemption to the Royalty or FTS income taxed only under the Domestic Act is a limited relief. Also, in certain instances where the appropriate taxes are withheld the foreign companies need to analyse whether they want to file return and claim a position different from withholding tax and claim refund of taxes withheld in India.

Whether the stay powers of ITAT would stay within its discretion?

 

The Constitution of India grants its citizens various fundamental rights, including the right to appeal under any Law. However, such right shall be explicit through an enactment and cannot be assumed. The Income-tax Act ('Act'), through section 253, enables an assessee to prefer an appeal before the Appellate Tribunal ('ITAT') against certain orders. Section 254(2A) while dealing with the timeline for disposing an appeal, grant power to the ITAT to deal with stay of demand. These provisions undergone certain changes in the Finance Bill, 2020 ('Bill').
 

Presently, there are 3 Provisos under section 254(2A), which deals with timeline as well power to grant stay. The First Proviso enables the ITAT to grant stay of a demand for a period not exceeding 180 days and shall dispose of the appeal within the said period (granting). Where the appeal is not disposed of within 180 days, the Second Proviso comes in to play for extension of stay for further period, in which case the aggregate period granted from the First and Second Proviso shall not exceed 365 days, and the appeal shall be disposed of, within the 365 days window of stay period (extending). As per the Third Proviso, where completion of appeal is delayed beyond 365 days, the order of stay granted shall get vacated after 365 days, even if the delay in disposing the appeal is not attributable to the assessee (vacating). Accordingly, the 3 stated Provisos may be understood in the order of granting, extending and vacating respectively.
 

 The Bill seeks amendments w.e.f. 1st April, 2020 to the First and Second Provisos. With the proposed amendment, for seeking grant of stay before ITAT, an assessee, as a pre-condition, shall either: (i) deposit a minimum of 20% of the amount of tax, interest, fee, penalty or any other sum ('disputed sum'); or (ii) furnish security equal to disputed sum. As per the proposed amendment to the Second Proviso, if appeal is not disposed of within the stay period by the ITAT, further extension of stay shall be granted only if assessee: (i) makes an application seeking extension; (ii) proves that the reason for delay in disposing appeal is not attributable to him; and (iii)  fulfilled the deposit of disputed sum or furnished security, as the may be.
 

 Historically, till 1999, there were no provisions under the Act to provide timeline for disposal of appeals by ITAT. Many assesses used this as an opportunity and filed appeals only to obtain stay to avoid payment of taxes, endlessly, despite the fact that the assessment order and demand are legal and reasonable. To discourage this frivolous practice and indefinite stay period, the Finance Act, 1999 for the first time, enacted time limit for disposal of cases through sub-section (2A) of section 254, which also enabled automatic vacation of stay beyond 180 days (now 365 days). The sub-section employs soft languages, in the form of 'where it is possible' and 'may hear and decide', and thus, indicating its nature, being an advisory to ITAT and not directive.
 

Delay in disposal of appeal
 

Though the sub-section seems to be mild in its language, the Third Proviso is bit harsh on the tax payers. The said Proviso mandates automatic vacation of stay, if the appeal is not disposed of with in the overall 365 days and the cause of such delay is not attributable to the assessee. Judiciary, in India, has been commented upon for the large backlog of disposal of cases and ITAT is no exception. With the new age business models, tax issues, more particularly in respect of transfer pricing or large searches, become too technical, time consuming and challenging and thus, resulting in high-pitched assessment orders. Many a times, appeals could not be concluded due to the pressure of pendency of cases.
 

In a case where an assessee is not responsible for the delay in disposal of appeal, it may cause irreparable injustice, if the stay gets vacated upon the culmination of 365 days limitation. Time and again, the Judiciary[i] held that where an assessee is not responsible for delay in disposal of appeal, any restriction to extend the stay beyond 365 days, shall be construed as arbitrary and invalid in law. The Apex Court in Pepsi Foods case[ii] has held that the ITAT has power to extend the stay beyond the period of 365 days, where the delay in disposal is not attributable to the assessee. The Apex Court further held that such unreasonable curbs are violative of Article 14 of the Constitution and the Proviso shall be struck down. Similar proposition has been followed by the Apex Court, recently, while dismissing the SLP filed by the Revenue in Comverse Network System's case[iii] . In view of the stated judicial positions, one could perceive that the matter of grant of stay beyond 365 days shall solely rest on the subjective satisfaction of the ITAT. Factors, including but not limited to assessment history, conduct & cooperation, issues in appeal, chances of recovery if assessee lost the appeal, hardship if immediate recovery is ordered etc. shall be critically evaluated to determine whether the assessee is entitled to stay.  Where the stay extension is not accorded by the ITAT, despite there is no fault on the assessee, extraordinary legal remedies in the form of Writ under Article 226/ 227 may be preferred before the High Court to ensure miscarriage of justice is not continued, apart from restoring the right of the tax payer.
 

Deposit of taxes   
 

 The Bill proposed, a new condition precedent to grant of stay, being deposit of 20% of disputed taxes. In the past, we have witnessed amendments which are directed towards curbing the powers of the ITAT, in terms of timeline for disposal of appeals, grant & extension of stay and so on and so forth. Seeking deposit of disputed taxes/ security are not new to Tax Law. Through an Office Memorandum (OM)[iv], CBDT has issued guiding principles in the matter of appeals before the CIT(A), to streamline the process of grant of stay.  As per the OM, 20% of outstanding demand shall be deposited with Revenue for grant of stay till disposal of appeal by the CIT(A). The quantum of sum sought to be deposited may be increased, if similar addition was confirmed earlier by the appellate authorities etc. or the addition was made based on credible evidence gathered through exercise of search, survey powers. Similarly, for the tax payer, there is a window for reduction of 20% threshold, if he demonstrates that there are favourable pronouncements, against the additions, which resulted in outstanding liability.  Accordingly, the OM is embedded with certain level playing principles to protect the parties to appeal. The Bill does not enshrine any of these discretionary provisions while adjudicating on stay by the ITAT. There may be for and against grant of such discretionary powers.
 

One must appreciate the fact that it is only in respect of appeals preferred by an assessee u/s.253(1) before ITAT, deposit of sum is envisaged and not in respect of departmental appeals u/s.253(2).  Assessee, who has not deposited the 20% sum and lost the case before the CIT(A), in any way, does not require any mercy by way of full stay and thus, mandating him to pay 20% as per the Bill appears to be justifiable. On the other hand, if the assessee has already paid 20% as per the OM while preferring an appeal before the CIT(A), there may not be a need for fresh deposit, while seeking appeal before the ITAT. It appears that in such eventuality, and on an application made, assessee would succeed in obtaining stay.
 

The view, in favour of incorporating such discretionary powers would reiterate the principle that the Appellate Authorities are bestowed with the duty, in deserving cases to grant of stay of demand, which are intertwined with appeal itself. Any failure on this part, would make the appeal process nugatory. The Apex Court in M.K.Kunhi's[v] case strongly endorsed this view.         
 

The Bill, by seeking 20% deposit of tax, without any discretion, may be looked upon as - encroaching few more rightful domains of the Appellate Authorities. No doubt, ITAT is a creature of Statute and it cannot function and deliver beyond what is sanctioned[vi]. However, we have witnessed successful endorsement of many subjective decisions of the ITAT in legal pronouncements. It appears that while dealing with stay petitions before ITAT, the principles laid down in the above stated decisions, shall continue to hold fort in favour of deserving tax payers, even after the introduction of new rule of 20% deposit.
 

Lastly, the proposed amendment could apply only prospective and thus, the orders made earlier shall be unaltered and remain operative till disposal of its appeal. This view has found favour from the decision of A.P.State Civil Supplies Corpn. Ltd. Vs.DCIT[vii].
 

                                                        _____________________________  
 

 
 

Budget Insights for National Pension Scheme

Growth in the National Pension Scheme (NPS) as per the Economic Survey for FY 2019-20

A total of around 3.06 crore subscribers (including Atal Pension Yojana) have enrolled under the National Pension System (NPS) till September, 2019. Assets under Management (AUM) under NPS has increased to Rs. 3.71 lakh crore as on 30 September, 2019, from Rs. 3.18 lakh crore as on 31 March, 2019, registering increase of 16.71%.

Present tax benefits of contribution to the National Pension Scheme Trust:

Contribution made to the fund in previous year (PY)

Allowed as a deduction under section 80CCD(1) up to 20% of gross income (in case of a self-employed taxpayer) or 10% of salary + dearness allowance (in case of the employee taxpayer). (Aggregate limit on deduction under section 80C, 80 CCC and 80CCD(1) is Rs.150,000 as per the provisions under section 80CCE.) Additional deduction of Rs.50,000 available under section 80CCD(1B) provided the investment is over an above the deduction claimed under section 80CCD(1).

Contribution made by employer to the fund in PY

Full deduction up to 10% of  basic salary plus dearness allowance [14% of basic salary plus dearness allowance in case of contribution by Central Government employer] is eligible under the provisions of section 80CCD(2) without any monetary limit. Employer's contribution is taxable under section 17(1)(viii).

Contribution to Tier II account by Central Govt. employees

Employee of the Central Government, contribution to a specified account to be held for three years under section 20(3) of the NPS pension scheme, is allowed as deduction under section 80C (2)(xxv) within the Rs 150,000 limit as per section 80CCE

Withdrawal from the fund during PY

Amount received on closure of the scheme is taxable as per section 80CCD(3) of the Act except on death. However, amount annuitized is not taxable as per section 80CCD(5) and also 60% of the total amount payable to an assesse is exempt from tax as per section 10(12A).

Partial Withdrawal from the fund during PY

25% of the total amount payable to an employee is exempt from tax at the time of partial withdrawal made in accordance with the relevant regulations as per section 10(12B) of the Act

 

Major Policy Initiatives by Budget 2020-21

•       To help easy mobility while in jobs, auto enrolment will be infused into the Universal Pension coverage, for which such mechanisms will be provided which can enable inter-operability and provide safeguards for the accumulated corpus. This should help people moving jobs to be able to claim their accumulated corpus in pension scheme.

•       Regulating role of PFRDAI requires strengthening. So necessary amendments would be carried out in Pension Fund Regulatory Development Authority of India Act that will also facilitate separation of NPS Trust for government employees from PFRDAI. This would also enable establishment of a Pension Trust by the employees other than government. This is to motivate citizens to plan for their old age.

•       It is proposed to expand Debt-based Exchange Traded Fund (ETF) by floating a new Debt-ETF consisting primarily of government securities for attractive investment opportunity for pension funds, amongst others.

•       Social security through pension penetration is aimed to be achieved through digital revolution. Initiatives in this regard and their components would be bench-marked to international standards and the indices which would be announced soon.

Tax Changes proposed in the Budget 2020- The following Income-tax amendments can have an adverse impact on the investors in the NPS:

•       A combined upper limit of Rs.7,50,000 is proposed to be capped in respect of employer's contribution in a year to NPS, superannuation fund and recognised provident fund and any excess contribution above the limit is proposed to be taxable as perquisite in the hands of the employees. (Entire employers contribution to NPS was anyway taxable as salary under section 17(1) of the Act as also employers' contribution to superannuation fund in excess of Rs. 150,000 was taxable as perquisite under section 17(2)(vii) of the Act and employers' contribution to recognized provident fund in excess of 12% of the salary was taxable as per Rule 6 of Schedule IV to the Act. The Budget now proposes to tax employer's contribution to NPS, superannuation fund, recognized provident fund above the monetary ceiling of Rs 750,000). 

•       Also annual accretion of interest, dividend or any similar amounts during the previous year to the balance at the credit of the fund or scheme to be taxed as perquisite to the extent it relates to the employer's contribution which is included in total income.

•       If the individual opts for the revised simplified tax slabs proposed under section 115BAC, no deduction shall be allowed interalia under section 80CCD with respect to employee's contribution to NPS. However, deduction for employer's contribution subject to limit of 10% or 14% of salary (as may be applicable) shall continue to be allowed. 

The above proposed amendment is applicable from the financial year beginning 1 April 2020 relevant to the assessment year 2021-22 onwards. The above amendments appear to be a disincentive to savings for old age which goes against the intention that the government had at the time of introduction of NPS.

Tax Reforms expected

In view of certain inconsistencies there was an expectation for amendments relating to exemptions or deduction for contributions to NPS as under:

•     Currently, the exemption provisions, under section 10(12B) for partial withdrawal is applicable only to assessee being employees, whereas contribution to NPS can be made by self-employed persons also. Thus, exemption under section 10(12B) should be extended to all individuals, including employees as applicable under section 10(12A).

•     Currently per section 80CCD(3) amount received on maturity including the pension amount is deemed to be income to the extent of deduction claimed under section 80CCD(1) and (2). Clarification is needed for the manner of computing income under section 80CCD(3) if a person receives maturity proceeds and pension from contributions that have not been allowed as deduction under section 80CCD.

•     Tier II contribution is allowed as deduction under section 80C(2)(xxv) of the Act from AY 2020-21 for employees of central government only. Similar deduction should be allowed to all individuals i.e. employees of all sectors and also to self-employed individuals.

•     Employers contribution is allowed as a deduction under section 80CCD(2) of the Act to the extent it does not exceed 14% of salary in case of Central Government Employees, and 10% of salary in case of State Government Employees and other employees. The rate should be uniform for all employers contributing to NPS. Further we understand that the State Government as employers are already contributing 14% of salary while the deduction should be allowed only to the extent of 10% of salary, so the employees of state government are being taxed on the differential amount of employers contribution during the year. 

There were expectations from the Budget to increase deduction for employers' contribution as well as employee and individual contribution to inculcate the habit of saving for old age. However, the tax changes proposed in the Budget could be a deterrent for savings and contributions to NPS. 
[This article is co-authored by Alifya Hakim (Director) and Tejashree Kulkarni is (Deputy Manager) with Deloitte Haskins and Sells LLP]

Budget 2020: Personal Income Tax New Regime vs Old Regime

In the Union Budget 2020, Finance Minister has announced new taxation regime for individual taxpayers on almost similar lines announced for corporate taxpayers in September'19. The scheme has been introduced with an objective that the middle-income group taxpayers would be able to file their tax returns themselves or with least professional assistance and documentation.

New Tax Rates

Under the new regime, income slabs for the tax rates have been increased to seven slabs, as against the historical four slabs. A brief comparison of the tax rates under the new and existing regime is given below:-

Restrictions

 

From the face of it, the new regime appears to be attractive, but it comes with its own limitations. Under the new regime, taxpayers would not be entitled to claim most of the famous major deductions and exemptions, such as Leave Travel Allowance (LTA), House Rent Allowance (HRA), Standard Deduction, Medical Insurance Premium, Set-off of losses under house property, exemption on clubbing of minor's income, additional depreciation, 80-C deduction (EPF, insurance premium, housing loan principal repayment), savings interest deduction, donation, deduction on family pension etc. However, deduction towards employer contribution to NPS and tax rebate under section 87A would continue to be available.

Option to exercise by Individual / HUF

Individuals and HUFs not earning any business income can exercise the option every year at the time of filing the tax return. Flexibility is provided for switching between the two regimes every year (i.e. Year 1- Old Regime, Year 2- New Regime, Year 3- Old Regime, Year 4- New Regime).

However, those deriving business income, having availed an option, can withdraw from the same only once.  In a case where they ceases to have business income, the flexibility of choice of option shall be available every year.

Comparative analysis

Whether the new taxation regime would be more beneficial, may be gauged from the below illustration. For our analysis, impact under both the regimes have been considered under different scenarios i.e. for a salaried employee claiming HRA (Scenario 1), salaried employee claiming deduction of interest on housing loan (Scenario 2) and a person having other sources income (Scenario 3).

Barring the above changes, deductions of INR 1.5 Lakhs i.e. 80C Deduction, INR 25,000 for mediclaim and INR 10,000 i.e. 80TAA savings interest deduction have been kept constant under the old regime of taxation for all the above scenarios. At the same time, such deductions are not available under the new regime.

        Amount in INR

Particulars	Scenario 1		Scenario 2		Scenario 3
	Old	New	Old	New	Old	New
Income	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000	15,00,000
HRA	(3,00,000)	-	-	-	-	-
Standard Deduction	(50,000)	-	(50,000)	-	-	-
Housing Interest Deduction	-	-	(2,00,000)	-	-	-
Interest Income	10,000	10,000	10,000	10,000	10,000	10,000
Gross Total Income	11,60,000	15,10,000	12,60,000	15,10,000	15,10,000	15,10,000
Deductions
80C	(1,50,000)	-	(1,50,000)	-	(1,50,000)	-
Medical	(25,000)	-	(25,000)	-	(25,000)	-
Saving Interest	(10,000)	-	(10,000)	-	(10,000)	-
Total Income	9,75,000	15,10,000	10,75,000	15,10,000	13,25,000	15,10,000
Tax	1,11,800	1,98,120	1,40,400	1,98,120	2,18,400	1,98,120

From the above tabulation, it may be inferred that the old regime of taxation would continue to be more beneficial for the taxpayers entitled to claim various deductions especially high value deductions such as HRA and housing interest. New regime would be more beneficial when there are no /few deductions.

 

Conclusion

The new scheme seems to have been introduced with an objective for providing relief to taxpayers. However, it seems to be beneficial only for the taxpayers having minimal deductions/ who have exhausted their house property losses, with a rider that their income is beyond a certain level. The scheme would also benefit senior citizens/ pensioners thereby enabling self- filling of tax returns, while they may also find the increased number of slabs to be more complex. Annual thorough comparative analysis, before filing the tax returns, would be inevitable.

Shift to Classical Dividend Taxation - An Impact on Industry and Investments

Amongst the various proposals contained in the Union Budget 2020-21 in the form of Finance Bill, 2020, a very significant one relates to the move towards classical form of taxation of dividends in the hands of shareholders, from the scheme of dividend distribution tax (DDT), which had been in vogue for almost twenty two years.

The current rate of DDT, after factoring in of surcharge and cess, is approximately 21.16% of net dividend; or in other words, approximately 17.47% of gross dividend. The shift towards taxing such dividends in the hands of shareholders at the normal rates of tax applicable for the recipient shareholders, would certainly increase the burden of tax for ultimate individual shareholders of Indian headquartered MNCs, as their individual tax rates are definitely likely to be higher than 17.47%, as aforesaid; and in most cases would exceed 30%, even without considering the staggered rates of surcharge and cess. Incidentally, this was one of the reasons for the capital market giving a thumbs down to the Union Budget, which got manifested in the stock markets collapsing by nearly 3% on the day of the Budget.

Foreign MNCs, investing in India, may stand to gain from the shift to the classical form of taxation of dividends in the hands of shareholders, as this would give them unambiguous opportunity to avail lower rates of taxes on dividends provided under tax treaties, which generally hover between 10 and 15%, with the same also touching a low of 5% in some cases, particularly in the treaty with Mauritius.

Of course, in order to avail of such favourable rates under tax treaties, foreign shareholders would need to satisfy both the beneficial ownership condition and principal purpose test (PPT) contained in the tax treaties, which, particularly the latter, have become arduous conditions to fulfil in the present regime of multilateral instruments (MLIs), interalia incorporating the safeguards for treaty shopping, as contained in BEPS Action 6.

While the tax treaty with Mauritius has not yet been covered under the MLI regime, as the said treaty partner had not notified its treaty with India for the said purposes, so as to remain unscathed from the attack of PPT as of now, yet for availing of the tax rate of 5% on dividends under the India-Mauritius tax treaty, the Mauritian shareholder would still need to satisfy the test of beneficial ownership; and also the rigours of general anti avoidance rules (GAAR) of India, since GAAR does not grandfather any investments made prior to 1st April, 2017 for the purposes of availing treaty benefits with respect to taxation of dividends.

Assuming foreign MNCs are able to satisfy the check-points of treaty shopping, as built in the texture of tax treaties, read with MLIs; and GAAR, as the case may be, then let us examine as to how the change in the texture of taxation of dividends, as above, may impact industrialisation and investments in India. The following table depicts the comparative effective tax rates (ETRs) of Indian companies with foreign lineage under the regimes of DDT and the proposed classical form of taxation of dividends in the hands of shareholders :

Scenarios	ETRs of Indian companies, with different headline tax rates (including surcharge & cess)
	34.94% (tax rate of 30%)	25.17% (tax rate of 22%)	17.16% (tax rate of 15%)
Current regime of DDT	46.31%	38.24%	31.63%
Treaty dividend tax @ 10%	41.45%	32.65%	25.44%
Treaty dividend tax @   5%	38.19%	28.91%	21.30%

It goes without saying that the headline tax rate of 17.16% (including surcharge and cess) is applicable for companies, which are set up and registered on or after 1st October, 2019; and engaged in the business of manufacture or production of articles or things; and also fulfils the various conditions stipulated in section 115BAB of the I T Act, which was introduced by the Taxation Laws (Amendment) Act, 2019.

While the proposed shift to the classical form of taxation of dividends in the hands of shareholders would certainly benefit the existing investments made by MNCs in the Indian economy, as is evident from the above table, the critical question, which arises for consideration is whether the said move shall by itself, and along with the tax reforms introduced by the Taxation Laws (Amendment) Act, 2019, attract significant foreign direct investments in the days ahead, being the unequivocal need of the day, in the backdrop of economic slowdown on account of slag in consumption; and rising levels of unemployment ?

It is a proven fact that mere slashing down of the corporate ETR does not automatically boost investments/ industrialisation for servicing the domestic consumption market of a country. Thus, in case the domestic consumption market of India, covering a population of 1.30 billion, was buoyant enough, then the Government would not have had to provide tax breaks or sops for encouraging investments for manufacturing and selling products in India. Both Indian and foreign MNCs would have automatically set up manufacturing facilities in India, being an otherwise low-cost country, for catering to such domestic market, since even if the ETRs were 46.31% or 38.24%, as above, the MNCs would have taken home significant amounts of post-tax profits emanating from large business operations in the country. This was the scenario with several developed countries, having high levels of ETRs at different stages of time in the past, e.g. USA, Germany, Japan, UK, etc.

However, it is a fact that due to several legacy issues, the general mass of people, who otherwise fall in the blue collared category of jobs, are significantly unemployed due to the manufacturing sector having never picked up since independence, commensurate to such large population. As a result, the majority of the population has remained unemployed with no propensity to spend or consume, which has resulted in the perennial depression of the domestic consumption market in India.

The Government had recently introduced the “Make in India” headline tax rate of 17.16%, i.e. after factoring in of surcharge and cess, vide the Taxation Laws (Amendment) Act, 2019, for companies set up and registered on or after 1st October, 2019; and engaged in the business of manufacture or production of articles or things, subject to the fulfilling of various conditions.

In view of the reasons discussed above, namely a depressed domestic consumption market and raging level of unemployment, both being inter-related issues, for the “Make in India” initiative of the Government to succeed, which would automatically address the issue of unemployment, the spurt in manufacturing needs to come from exports, where global MNEs may be enticed to set up contract/ toll manufacturing facilities in India for catering to the global market, or in other words, using India as the global manufacturing hub for exports.

Setting up of manufacturing facilities by foreign MNEs for exports under the contract/ toll manufacturing model, would generate significant employment for the masses, not only in the manufacturing facilities, but also in ancillary industries and service companies, which would automatically be set up in order to cater to such manufacturing facilities. Such generation of employment would result in the masses being blessed with disposable income for spending; and thus enlarging the domestic consumption market, which is when both foreign and Indian MNEs would automatically set up manufacturing facilities in India to cater to such huge domestic consumption market without even feeling the need to be invited through any further fiscal reforms. India needed to boost exports in the nineteen eighties and nineties for augmenting foreign currency reserves. For the reasons stated above, India again needs to boost exports, but this time for industrialisation and corresponding job creation; and come out of the vicious cycle of unemployment.

When a country may be looking at positioning itself as a global manufacturing hub for exports of foreign MNCs, then ETR has a very strong role to play in order to give it a competitive edge over similarly placed economies, particularly in the same region. It has been noticed above that for a tax-treaty dividend tax rate of 10%, the ETR for newly set up manufacturing companies would work out at 25.44%, while for a tax-treaty dividend tax rate of 5%, the ETR for such newly set up manufacturing companies would work out to 21.30%.

The ETRs of corporates in some of the Asian countries  which are competitors of India as attractive destinations for foreign MNEs for setting up of global manufacturing hubs for catering to the export market, are as follows :

Name of country	ETR
Malaysia	24%
Vietnam	20%
Thailand	28%
Taiwan	28%

It may be borne in mind that the aforesaid four countries have far better infrastructure facilities as compared to India; and accordingly India may not automatically be considered as the preferred destination of the foreign MNEs for setting up of global manufacturing hubs for exports under the contract/ toll manufacturing models.

It is thus imperative on the part of India to peg its ETR for newly set up manufacturing companies at somewhere between 20 and 22%, in order to have the clear competitive advantage over its peers in the Asian market, for making the “Make in India” initiative a real success; and also to change its wheels of fortune forever.

It has been noticed above that a tax-treaty dividend rate of 5% achieves the desired level of ETR of 21.30%, which would clearly provide India a level playing field against its competitors in the Asia-Pacific market. However, it is cliché that in the current regime of PPT under MLIs and also GAAR, MNCs would not indulge in treaty shopping for trying to achieve such tax-treaty dividend rate of 5%.

Thus, in the larger interest of the economic growth of the country, the Government may consider to provide a specific dispensation under the domestic tax laws of the country, to peg the all-inclusive tax rate on dividends paid by companies, which opt for the benefit of section 115BAB of the I T Act, to 5%.

While on the subject of the “Make in India” initiative, vis-à-vis the scheme for availing lower headline tax rate of 17.16%, as above, it is worthwhile to note that section 115BAB provides that the newly set up company should not be engaged in any business other than the business of manufacture or production of any article or thing and research in relation to; or distribution of, such article or thing manufactured or produced by it.

Considering the setting of the term “distribution” in the above clause, i.e. succeeding the conjunction, “or”, it looks like that the Government intends that while the company needs to be otherwise engaged in the business of manufacture or production of any article or thing, if it is also engaged in distribution of the products so manufactured by it, then the activities of distribution would also be covered within the eligibility criterion.

However, the setting of the word, “research” in the above clause, i.e. succeeding the conjunction, “and”, gives an impression that carrying out of research in relation to the products manufactured or produced by the company, would be a precondition or prerequisite for the eligibility. In other words, mere manufacturing of products, without carrying out research with respect to the same, may not meet the eligibility criterion for the relevant section.

If the above is the actual intention of the Government, then it would defeat the whole objective and purpose of the tax concession or “Make in India” initiative. A large foreign MNC, on being enticed by the concessional tax rate, may still look at setting up of a large manufacturing plant in India for catering to the global market under the contract/ toll manufacturing model, however, it may not wish to carry out research and development (R&D) activities in India, albeit under a contract R&D model for a variety of reasons, including lack of infrastructural facilities, skill-set, etc. Requiring the foreign MNC to mandatorily relocate R&D facilities in India, may discourage the foreign MNC from setting up of the global manufacturing hub in India.

Thus, the word, “and”, preceding research, may be amended to “or”, in order to bring the criterion in line with distribution of products. In other words, the eligibility criterion should be that while the company needs to be otherwise engaged in the business of manufacture or production of any article or thing, in case it is also engaged in distribution of the products; or research in relation to the products, so manufactured by it, then the activities of research or distribution would also be covered within the eligibility criterion. Therefore, if a newly set up company decides not to carry out any R&D functions with respect to the manufacturing of products; and such R&D functions may be carried out by some other entity within the MNC group, then the said company should not be disentitled to the concessional “Make in India” rate of tax.

Now, reverting back to the proposal of introducing the classical form of taxation of dividends, in order place the Indian shareholders at par with foreign shareholders, enjoying benefits of tax treaties, which in most cases result in 10% tax on dividends, the Government should prescribe a uniform all-inclusive tax rate of 10% for Indian shareholders.

Ideally, Indian shareholders should not be unduly discriminated against foreign shareholders, who may have the benefit of enjoying lower tax rates provided under tax treaties; and this is the bare minimum, which the Government may need to do for the Indian shareholders, investing in the capital market.

The above actions would surely revive the sentiments within the capital market, which stood crestfallen post announcement of the budget. It is respectfully submitted that the present times demand decisions being taken by the Government keeping the overall macro-economic scenario of the country, without worrying too much on the issues relating to fiscal deficits, vis-à-vis collection of corporate taxes. Even if the measures suggested above result in a slight drop in tax collection, the strategic moves would certainly over-compensate all fiscal deficits in the years ahead through greater industrialisation, mobilisation of funds, generation of employment; creation of demand and enhancement of the consumption, all of which would lead to surge in overall creation of income and wealth for the masses and corporate houses; and accordingly collection of larger amounts of tax.

Budget 2020: Possible impact areas for Transfer Pricing regime

On 1 February 2020, Hon'ble Finance Minister Ms. Nirmala Sitharaman presented Union Budget 2020, first budget of this new decade, in Lok Sabha. Considering the current economic scenario, expectedly Budget 2020 was focused on bringing certain structural reforms and promoting the infrastructural development in India. While presenting the tax proposals, Hon'ble Finance Minister reiterated the commitment of the current government to stimulate growth, simplify tax structure, bring ease of compliance, and reduce litigation. Finance Bill 2020 has proposed plethora of changes in direct tax as well as indirect tax front.
In this article, we have endeavoured to assess the impact areas pertaining to transfer pricing ('TP'). Further, we have also endeavoured to cover implications on TP as a result of amendments proposed under other sections of the Income-tax Act, 1961 ('the Act').
(A)      Providing certainty on attribution to Permanent Establishment ('PE'): 
Whilst constitution of PE itself remains a contentious issue, attribution of profit to an admitted PE under section 9(1)(i) of the Act is also equally vexed. On one hand the Assessee argues that arm's length remuneration should be considered as an appropriate return even covering the attribution of profit to an alleged PE, on the other hand, the Assessing officer alleges that the attribution of profit to a PE should be over and above the arm's length remuneration. This stand of the Assessing officer was further supported by the Public Consultation paper released by Central Board of Direct Taxes ('CBDT') dated 18 April 2019 relating to amendments to the Rules for attribution of profits to PEs. This public consultation paper endorsed a view that arm's length remuneration to PE based on functions performed, assets used and risk analysis cannot be considered to be an appropriate measure of profit attribution to PE and hence, suggested, certain formula based approach for arriving at such profit attribution. Memorandum to Finance Bill explains that multiple representations were made before the CBDT stating that the attribution of profits to the PE of a non-resident under section 9(1) of the Act in accordance with Rule 10 of the Income-tax Rules, 1962 ('the Rules') also results in avoidable disputes in a number of cases. This could be achieved by prescribing a mechanism which would provide certainty on this aspect.
In view of the above and to provide certainty to cases involving attribution of profit to PE, Finance Bill 2020 has proposed to amend section 92CB (i.e. by notifying safe harbour rules rules) and section 92CC of the Act (i.e. advance pricing agreement for 5 future years as well as 4 roll-back years - read with Memorandum to Finance Bill). This amendment is proposed to be made applicable from AY 2020-21 and subsequent assessment years ('AYs').
Pertinent here to note that newly substituted section 92CC(3) of the Act starts with a non-obstante clause i.e. income agreed under the advance pricing agreement ('APA') will override any other rules made under the Act (i.e. Rule 10) in respect of determination of income referred under section 9(1)(i) of the Act. For this reason, the proposed amendment assumes further significance since it would provide certainty from TP as well as corporate tax perspective.
It is imperative to mention that such non-obstante clause has not been inserted under section 92CB of the Act. It will be interesting to know whether non-insertion of non-obstante clause is intentional or an inadvertent miss-out. One would wonder whether the Assessing officer is still left with a level playing field to allege that the income determined under safe harbour rules is merely from the standpoint of TP provisions and a separate income determination is required under Rule 10 of the Rules from a corporate tax perspective or whether the use of word 'shall' while amending section 92CB makes it mandatory for AO to follow safe harbour rules only. We hope that CBDT will clear the air on this aspect before the Hon'ble Parliament passes the Finance Bill.
It will be a wait and watch situation as to what approach would be adopted by Indian APA authorities while determining the attribution of profit to PE and also, how the rules would be framed under the safe harbour rules for attribution of income to PE. Also, it would be interesting to understand how the profit attribution principles under the tax treaties would be factored in while framing the rules or while negotiating an APA.
Apart from above, it is also important to note that admission of constituting a PE in India is a pre-requisite to claim the benefits under the proposed amendment to section 92CB and 92CC of the Act and to achieve certainty.
(B)      Preponement of due date of certain TP compliances:
Finance Bill 2020 has proposed to amend section 92F(iv) of the Act which defines 'specified date' for certain TP compliances. It is proposed that specified date would mean, the date one month prior to the due date for furnishing the return of income under section 139(1) of the Act. Presently, in cases wherein the taxpayer is required to furnish the TP certification in Form 3CEB, the due date for furnishing the tax return is 30 November of the relevant AY. Hence, in effect on combined reading with of section 92F(iv) read with section 139(1) of the Act, the due date for following TP compliances is proposed to be preponed to 31 October of the relevant AY:
·         Maintenance of TP documentation as prescribed under section 92D of the Act read with Rule 10D of the Rules
·         Filing of accountant's report in Form 3CEB
Above amendments are proposed to take effect from AY 2020-21 and subsequent AYs.   
Pertinent here to mention that the due date for filing of Master File in Form 3CEAA still continues to be 30 November of the relevant AY since this due date is linked to the date of filing tax return in India under section 139(1) of the Act.
For the taxpayers having international transaction(s), AY 2020-21 is going to be an eventful compliance time in view of the below tabulated due dates:

Sr No	Compliance obligation	Due date
1	Filing of Tax audit report in Form 3CD	31 October 2020
2	Maintenance of TP documentation as prescribed under section 92D of he Act	31 October 2020
3	Filing of accountant's report in Form 3CEB	31 October 2020
4	Any other certifications as applicable such as Form 29B, Form 56F, etc.	31 October 2020
5	Completion of TP assessment proceedings for AY 2017-18 under section 92CA of the Act (in case such proceedings are initiated)	31 October 2020
6	Filing of Master File in Form 3CEAA	30 November 2020
7	Filing of return of income	30 November 2020

Note that from next year onwards, whilst all other dues dates above would continue to remain the same, the date of completion of TP assessment proceedings would be preponed in view of phased preponement in the time limits for completion of assessment of tax years AY 2018-19 and onwards.
(C)      Amendments proposed in section 144C in connection with Dispute Resolution Panel:
As per current section 144C of the Act, the Assessing officer is required to forward a draft assessment order in case of certain Eligible Assessees where he proposes to make any variation in the income or loss returned and such variation is prejudicial to the interest of the Assessee. Eligible Assessee is defined under section 144C(15)(b) of the Act to include (i) any person in whose case TP adjustment has been made under section 92CA(3) of the Act or (ii) any foreign company.
Finance Bill 2020 has proposed following two amendments to section 144C of the Act:
(i)     Extending applicability of section 144C of the Act to any non-resident Assessee:
Currently, in case of non-resident Assessee, the Assessing officer is inter alia required to forward draft assessment order only in case such non-resident Assessee is a foreign company and where any variation to the returned income/ loss proposed by such Assessing officer is prejudicial to the interest of the Assessee. In view of this, other non-resident Assessees like individual or partnership firms were ineligible to be covered within the ambit of section 144C of the Act.
It is now proposed to include any non-resident Assessee within the ambit of section 144C of the Act. Hence, the AO would now be required to pass draft assessment order in case he proposes to make any variation which is prejudicial to the interest of any non-resident Assessee. This is a welcome amendment since any non-resident Assessee would now also be covered under the fast track dispute resolution mechanism.
(ii)    Removal of words 'income or loss returned' from section 144C(1) of the Act:
There has always been a grievance amongst the non-resident Assessee that only those cases wherein the Assessing officer has proposed any variation to the income or loss declared by the Assessee in its return of income are covered within the ambit of DRP. In case, any action of the Assessing officer does not result in any variation to the income or loss returned by such non-resident Assessee, such case would not get covered under the ambit of section 144C of the Act. Certain such examples would include dispute on the rate at which a particular income is taxable in India (under domestic tax laws or under the applicable double tax avoidance agreement), claim of foreign tax credit, etc.
Finance Bill 2020 has proposed to remove the words 'income or loss returned' from section 144C(1) of the Act. Hence, in effect, this is again a welcome amendment since it broadens the scope of cases that could be covered under the ambit of section 144C of the Act and helps in providing fast track dispute resolution mechanism.
(D)      Newly introduced Penalty under section 271AAD of the Act for false entry or omission entry:
Finance Bill 2020 has proposed to insert a new penalty under section 271AAD of the Act for taxpayers whose books of accounts include (i) any false entry; or (ii) any entry relevant for computation of total income of such taxpayer has been omitted to evade tax liability. While explaining the intent behind introducing such penal provisions, the Memorandum to Finance Bill explains that in recent past, Goods and Service tax authorities have found that certain companies have claimed fraudulent input tax credit or obtained fake invoices from suppliers, etc. Further, this section also empowers AO to levy penalty on a person who causes the taxpayer to make such entry. Hence, in order to curb such practice, a new penal section is proposed to be inserted. Penalty under this section is proposed to be equal to the aggregate amounts of such false entries or omitted entry.
Term 'false entry' is defined in Explanation below section 271AAD(2) of the Act. Explanation (b) inter alia defines false entry as under:
“(b) invoice in respect of supply or receipt of goods or services or both issued by the person or any other person without actual supply or receipt of such goods or services or both”
Whilst the above Explanation and intention behind the insertion of new penal section is to curb malpractices followed by certain taxpayers for evasion of taxes, it can also have a far-reaching consequence in cases wherein certain taxpayers could have genuine hardship in establishing actual receipt of service.
This is further significant in the context of TP wherein the transfer pricing officers ('TPO') treat the arm's length price of the intra-group management charges as Nil alleging that Indian taxpayers have not received any service from its associated enterprise and hence, should not have made any payment for the same. TP being a subjective exercise, this view could be taken by TPOs even after the taxpayer has furnished some documentation to justify receipt of the service. Even though it would be AO's discretion to levy penalty under this section, only time can tell whether the newly inserted penal provision would add to the already existing TP litigation in India thereby causing further hardship to the taxpayers merely on account of two different viewpoints on what constitutes actual receipt of service.
Worthwhile here to reiterate that introduction of the said penal provision further reinforces the need for the Indian taxpayers to maintain robust documentation to substantiate actual receipt of services and also the benefits received from such payments.
Further, it is to be noted that this section starts with 'without prejudice to any other provisions of the Act'. Hence, penalty to be levied under this section would be in addition to the penalty prescribed under section 270A or 271AA of the Act. Whilst it is a generally accepted principle that a person cannot be punished twice for the same offence, insertion of this penal section surely promises additional litigation in India in near future. Hence, it would be a welcome move if CBDT rationalized this provision proactively before the Hon'ble Parliament passes the Finance Bill.
This new section is proposed to be made effective from 1 April 2020. Section 271AAD, being a penal provision, cannot be made retrospectively applicable for past assessment years. Hence, a question arises whether this section will be applicable for AY 2020-21 or AY 2021-22 and onwards?
(E)      Applicability of TP compliances in the hands of non-resident shareholder earning Dividend income from India:
Finance Bill 2020 has proposed to abolish the Dividend Distribution Tax ('DDT') and reintroduced the classical system of dividend taxation in the Act. Dividend has become a taxable income in the hands of the shareholder and Indian taxpayer declaring such dividend could be required to withhold taxes on the same.
Since dividend income was an exempt income, earlier there was no TP compliance obligation in the hands of non-resident shareholder who earned only dividend income from India. However, in view of the budget proposal, the non-resident shareholder earning only dividend income from India would also be required to undertake the following TP compliances in India:
·         Filing of accountant's report in Form 3CEB
·         Maintenance of TP documentation as prescribed under section 92D of the Act (provided the aggregate amount of international transaction exceeds INR 1 Crores)
·         Filing of Master File in Form 3CEAA (provided the amount of international transactions exceed INR 50 Crores and other conditions in under section 92D read with Rule 10DA of the Rule are also met)
Real challenge would arise in determining the approach to be followed for benchmarking such transaction since declaration of dividend is a management decision which varies from company to company depending upon various commercial considerations such as proposed expansion plans in India, repaying the existing debt, working capital requirement, etc. Hence, there cannot be a uniform benchmarking approach or method to test the arm's length nature of such transaction. 
(F)       Interplay of re-introduced classical system of dividend taxation vis-à-vis secondary adjustment provisions:
As mentioned above, after abolition of DDT, dividend has become taxable in the hands of the shareholder. In the context of the non-resident shareholder, the Indian taxpayer would be required to withhold taxes at the rate as per the applicable tax treaty or under the Act (i.e. twenty percent plus applicable surcharge and cess) whichever is more beneficial. There is a likelihood that foreign shareholder would be able to claim credit of such withholding tax in its home country (inter alia depending upon the language in tax treaty) and thus, effectively does not have any additional tax impact for the Group as a whole.
Finance Act (No. 2) of 2019 last year inserted a new sub-section (2A) under section 92CE of the Act which provides an option to the Indian taxpayer to not repatriate the amount of primary adjustment to India by opting to pay an additional tax at the rate of eighteen percent (plus applicable surcharge and cess). This was introduced to recover the possible loss of DDT had the money been actually repatriated to India. With the reintroduction of classical system of dividend taxation, it would be rational to link the rate of tax under section 92CE(2A) of the Act to the rate at which such dividend would have been taxable in India in the hands of the shareholder. Appropriate representations could be made to CBDT to rationalize the secondary adjustment provision.
In view of the combined reading of section 92CE(2A) of Act read with the amendment proposed by Finance Bill 2020 regarding abolishment of DDT, one need to make cautious decision while evaluating which is a more beneficial option for the Group as a whole i.e. (i) whether to repatriate the amount of primary adjustment in India and subsequently declare dividend from the same; or (ii) not to repatriate the amount of primary adjustment to India but pay additional tax under section 92CE(2A) of the Act.
Concluding remarks:
While keeping the word on reduction of litigation in India, it is a welcome proposal to cover disputes in relation to the attribution of profit to PE under the safe harbour rules and APA. This will surely help the taxpayers to achieve certainty from litigation on this vexed issue. Separately, expansion of the scope of section 144C of the Act would definitely assist non-resident taxpayers in fast track resolution of the disputes. Whilst more clarity on other burning TP issues would have been more appreciated, the current budget proposals will go a long way in reduction of TP disputes in India.
[The article is co-authored by Swapnil Bafna (Senior Manager) from EY India]

Union Budget 2020 - Four Key Takeaways from Transfer Pricing

Overall, the proposed amendments would go a long way in restoring investor faith in Indian economy.

Union Budget 2020 - Four Key Takeaways from Transfer Pricing

Recently, Indian economy faced a plethora of headwinds, both globally as well as domestically. The Government has taken several steps to promote investments and boost Indian economy. In the Union Budget 2020, it was anticipated that the Government would continue its reforms journey to simplify tax regime and provide certainty as well as clarity to taxpayers.

The Union Budget, 2020 has proposed the following amendments in Transfer Pricing provisions:

1.      Attribution to Permanent Establishment ('PE'):

Concerns have been rising globally on how the profits should be attributed in respect of digital and other businesses. The technology revolution and rise of digital economy has made the concept of 'physical presence' redundant. The existing tax rules could be difficult to apply for the taxation of enterprises which do not need 'physical presence' nexus anymore to actively participate in the economic lifecycle of a taxing jurisdiction resulting in a mismatch between the place of generation of profits and the place of taxability of such profits.

The Authorized OECD Approach ('AOA') in respect of profit attribution to a PE is based on the functions, assets and risks ('FAR') analysis, to which India has disagreed stating that due weightage also needs to be given to 'demand side factor' i.e. sales, alongside 'supply side factors' i.e. FAR.

In the light of OECD's work around digital taxation, India's disagreement with AOA and amendment proposed in existing Rule 10 of Income-tax Rules, 1962 (as per public consultation paper on modus operandi related to attribution to PE), it is indeed a positive step on the part of the Government of India to extend the existing Advance Pricing Agreement ('APA') program as well as Safe Harbor ('SHR') mechanism to achieve certainty with respect to such complex topic.

The APA authorities conduct detailed fact finding, develop understating of business through site visits and interact with business personnel etc. Considering their pragmatic, cordial and focused approach, the APA authorities would be in an ideal position to deal with the cases of attribution of profits.

With respect to section 92CC (i.e. APA), the amendment will take effect from 1st April 2020 and accordingly, will apply to an APA entered into on or after 1st April 2020. It may be worth evaluating to cover the same in the APAs on the verge of finalization / agreement.

With respect to section 92CB (i.e. SHR), the amendment will take effect from 1st April 2020 and will, accordingly, apply to the assessment year 2020-21 and subsequent years. This signals the intent of the Government to bring new SHR guidance as existing provisions were applicable only till FY 2018-19. Considering lukewarm response to the earlier SHR provisions which have been onerous for the taxpayers, the industry is hopeful that new provisions would be far more pragmatic, simple and practical to implement.

It is highly anticipated that the public consultation paper issued by the Central Board for Direct Taxes ('CBDT') dated 18th April 2019 on the proposals for amendment to the rules for attribution of profit to PE would be finalized soon. Various stakeholders have already provided recommendations for dilution of certain proposals of the CBDT.

Now, the CBDT has a mammoth task on hand to rationalize and finalize the amendments to profit attribution rules which is fundamentally diverse from conventional and internationally accepted principles for attribution of profits.

Till such amendments are finalized, one would wonder how Indian tax authorities would deal with profit attribution cases under the APA and SHR provisions. Several tax payers with existing and new APA would eagerly await to see the approach of the Indian tax authorities.

One could expect a movement at least in the Unilateral APA cases. However, the progress in the bilateral APA and SHR would depend upon the alignment in the amendments proposed by India in the profit attribution rules versus international developments with respect to profit attribution rules. 

2.      Preponement of due date for accountant's report in Form no. 3CEB:

It has been proposed to prepone the due date for filing of accountant's report in Form no. 3CEB to 31st October in place of 30th November.

The Memorandum to the Finance Bill, 2020 specifies that aforesaid amendment is primarily proposed to enable pre-filing of returns and hence, various reports such as accountant's report in Form no. 3CEB, tax audit report in Form no. 3CED, etc. shall be required to be filed by 31st October.

Considering that financial data of the comparable companies for relevant year is usually not available in public domain till the end of October month of following year, the taxpayers may find it difficult to conduct comparability analysis and to find suitable comparables with latest financial data while preparing their transfer pricing documentation by 31st October.

The Indian transfer pricing provisions permit usage of multiple year data and range of margins; thus, non-availability of relevant financial year data may not result into significant challenge to the taxpayers. However, in order to minimize disputes, it would be important for the Indian tax authorities to also adopt the contemporaneous data as available till 31st October only during the course of transfer pricing audits. 

3.      Extension of exemption in respect of limitation of interest deduction under section 94B:

The proposal to extend the exemption of such limitation to interest arising out of debt issued by an Indian branch of a foreign bank w.e.f. AY 2020-21 is a welcome clarification for the taxpayers and the same provides respite to several foreign banks' operating in India through a branch at same level playing field with Indian banks. It may be considered to make such amendments effective retrospectively. 

4.      Extension of scope of Dispute Resolution Panel:

The eligible tax payers were puzzled whether they can opt for DRP route in absence of variation in income/ loss, due to dispute with respect to tax credit, tax rate and other matters.

It has been proposed to extend the scope of Dispute Resolution Panel to all the non-residents i.e. other than a company as well w.e.f AY 2020-21 and further, to include cases where Assessing Officer has proposed any variation which is prejudicial to the interest of the assessee, within the ambit of section 144C of the Income-tax Act, 1961. This is a welcome move for all the matters especially involving any non-residents (such as Partnership firms, Limited Liability Partnerships, individuals, etc.). 

Conclusion:

The Government's efforts are laudable in providing sufficient time to the taxpayers to enable them to plan their transfer pricing policies and compliances in advance.

Appropriate framework and guidance with respect to profit attribution is now awaited from the authorities for smooth implementation of the aforesaid provisions and provide due clarity to the authorities as well as taxpayers to expedite pending matters.

[This article is co-authored by Anjul Mota (Associate Director, Global Transfer Pricing Services, B S R & Co LLP)]

Budget 2020 - Impact on Charitable Institutions

The Hon'ble Finance Minister, Mrs. Nirmala Sitharaman, presented the Union Budget, 2020 on 1 February 2020. Among various proposals, significant changes and amendments are proposed in relation to charitable institutions.  

The proposed amendments in this regard can be divided into following broad categories:

A.    Rationalisation of tax-exemption registration process;

B.    New reporting obligation on receipt of donation. 

The above key amendments are discussed in detail below: 

A.   Rationalisation of tax-exemption registration process 

The Hon'ble Finance Minister, in her budget speech, highlighted that the process of registration for charitable institutions is currently manual and scattered all over the country. Hence, to simplify the compliance for new and existing institutions, it is proposed to make the registration process electronic for all new as well as existing charitable institutions. 

These changes in process are proposed for income-tax registration u/s 12A of the Income-tax Act ('IT Act') as well as for granting registration for deduction to donors u/s 80G of the IT Act. 

Coming to the fine print, the proposed amendments in the registration requirements lay down various changes depending upon whether the charitable institution is an existing one with a valid tax exemption registration issued in past or a new charitable institution seeking registration in near future. 

5 years registration - for existing charitable institutions 

As against registration which is currently granted for perpetuity (until revoked by tax authority), it is now proposed to grant the registration for a limited period of 5 years at a time. This is proposed with the intent to keep a check on the charitable institutions on periodic basis and to ensure that the conditions of approval are adhered to.  

Further, it is also envisaged that periodic renewal of registration shall lead to a non-adversarial regime wherein tax authorities would avoid conducting roving inquiry in the affairs of the exempt entities on a day-to-day basis. 

Accordingly, the existing and registered charitable institutions will now need to re-apply under the new regime within 3 months of the proposed amendments coming into force, i.e. by 31 August 2020. 

Provisional registration - for new charitable institutions 

The concept of 'provisional registration' is proposed for new charitable institutions, which are not already registered and have not started any activities. Such provisional registration would be valid for 3 years. Subsequently, such provisionally registered charitable institutions are required to apply for 5 years registration within 6 months of commencement of activities or atleast 6 months prior to expiry of 3 years. 

The proposal for provisional registration is a welcome move considering the practical issues faced by the new charitable institution in obtaining tax-exemption registration before commencement of activities. This would avoid a lot of inquiries and significant litigation at present in granting approvals by the tax authorities in relation to carrying out charitable activities at the time of application. 

As a logical clarification, the fine print also specifies that all the existing applications pending with tax authorities will now be deemed to be application for provisional registration under the new regime. With this, now it is expected that the existing applications will be disposed-off quickly by the tax authorities. 

Proposed timelines for application for income-tax registration 

In this regard, while details and relevant forms for applying for registration are yet to be issued, the proposed amendment sets forth below timelines for applying for registration: 

Sr. No.	Particulars	Timeline
i.	Charitable institution already registered under the erstwhile regime	On or before 31 August 2020
ii.	New charitable institution applying for provisional registration under new regime	At least 1 month prior to the commencement of the previous year relevant to the assessment year from which the said registration is sought
iii.	Where institution has been provisionally registered under new regime	Within 6 months of commencement of its activities or at least 6 months prior to expiry of 3 years, whichever is earlier
iv.	Where institution is granted 5 years registration under new regime and the said registration is nearing expiry	At least 6 months prior to expiry of 5 years registration period
v.	Where the institution has adopted or undertaken modifications of the objects which do not conform to the conditions of registration	Within a period of 30 days from the date of the said adoption or modification

 

On a plain reading of the timeline for provisional registration by new charitable institutions, it appears that the benefit of income-tax registration will not be available for the year in which the entity is formed as the application for exemption is to be made a month prior to the financial year for which registration is sought. 

However, there seems a lacuna in the law, under an already existing provisions of IT Act, i.e. Section 12A(2), the benefit of exemption is granted in relation to the income from the financial year in which application for registration is made. 

Granting of registration by Principal Commissioner / Commissioner 

On a plain reading of the fine print of the Finance Bill 2020, it appears that tax authorities are required to seek minimum documents / inquiry at the time of granting provisional registration to existing institutions for the first time under new regime. 

In line with the intent laid down in the memorandum, detailed inquiry is prescribed only at the time of granting 5 year registration at a later stage. Having said which, ground-level approach once the new regime is implemented, remain to be seen. 

B.   New reporting obligation on receipt of donation.  

Another important move by the Government in the area of charitable donations, is the proposed requirement of filing periodic return of donation and issue of certificate of donation to donors (appearing to be similar to TDS returns and TDS certificates) by the charitable institution. 

While the process, timeline and mechanism are yet to be unveiled, the intention of the Government in bringing this change is to ease the process of claiming deduction of donation by donors and maintaining the central repository of the donations made across the nations in the charitable space. 

Going forward, tax-deduction for donations u/s 80G to the donors shall be allowed only if the aforesaid statement / return is furnished by the charitable institution, failing which the institution will be subject to fee and penalty on the charitable institution. 

It is proposed that the donee's information shall be pre-filled based on the statement / return of donation filed by the donee institution and would lead to a hassle-free claim of deduction by assessee. 

Key takeaways 

While the above processes will bring additional compliances for the charitable institutions, it will surely bring greater transparency and monitoring of activities of charitable space. The Government has already been strictly monitoring the foreign donations through FCRA authority, the above changes shall also bring the domestic donations under its monitoring mechanism. 

The aforesaid process changes seems to be in line with the Government's initiatives to bring greater transparency and governance by use of digital means and to create centralised registry of charitable institutions which may be useful in future for other regulators

[The article is co-authored by Naman Shah (Senior Manager, Deloitte Haskins & Sells LLP) and Drashti Shastri  (Deputy Manager, Deloitte Haskins & Sells LLP)]

Lessons Not Learnt!!

Vide clause 97 of the Finance Bill, 2020, the Central Government has sought to amend the first and second proviso to section 254(2A) of the Income-tax Act, 1961 (“ITA”) with effect from 01.04.2020.  Section 254 of the ITA provides for the power of the Income Tax Appellate Tribunal (“Tribunal”) to pass orders in an appeal as it thinks fits.  These powers have consistently been tested and in the context of granting stay on tax demand during the pendency of appeal, this power has been specifically recognized by the Apex Court in the celebrated decision of M.K.Mohammed kunhi [TS-5-SC-1968].

Sub-section (2A) to section 254 of the ITA was inserted in 1999 to provide an outer limit of four years in which the Tribunal was directed to dispose off a particular appeal as far as possible.  It was for the first time, that in 2001, the legislature, by way of insertion of first and second proviso to section 254(2A) of the ITA, explicitly introduced a 180 days limit on the operation of a stay order passed by the Tribunal beyond which stay could not be extended.  The proviso, as it stood then, could really not have stood the test of non-arbitrariness as it would result in an appeal being defeated even if the assessee was not at fault, as in the meantime the revenue could proceed against the assets of the assessee.  Therefore, the said period was allowed to be extended to a total of 365 days, by way of amendment to first and second proviso as well as insertion of third proviso to section 254(2A) of the ITA in 2007, beyond which stay could not be extended.  The arbitrariness of such provision was read down by the Bombay High Court in Narang Overseas (P.) Ltd. vs. Income-tax Appellate Tribunal [TS-5665-HC-2007(BOMBAY)-O] so as to allow the Tribunal to extend stay beyond 365 days on good cause being shown.  Such interpretation was turned around by the legislature by further amending the third proviso to section 254(2A) of the ITA in 2008, by virtue of which it was clarified that the period of stay could not be extended beyond 365 days even if the delay in disposal of the underlying appeal was not attributable to the assessee.  However, the latter underlined part of the provision was struck down in the case of Pepsi Foods (P.) Ltd. vs. ACIT [TS-5873-HC-2015(DELHI)-O] as being unconstitutional, wherein it was held that equating “well behaved” assessees and those who cause delay in the appeal proceedings is violative of Article 14 of the Constitution.  The Delhi High Court emphatically clarified that the Tribunal had the power to grant extension of stay beyond 365 days in deserving cases. 

By way of the newly introduced Finance Bill, the Government is now again endeavouring to interfere with the judicial discretion vested in the Tribunal while imposing a threshold of 20% payment towards outstanding tax demand in application seeking stay.  From a plain reading of the amendment sought, it appears that all the applications seeking extension of stay coming up after 01.04.2020 would also have to meet the same requirement.  Not only is this a retrograde step, it diminishes the confidence in the Government, which seems to be completely oblivious to the fact that the Tribunal in spite of its best efforts is unable to dispose off the appeals owing to barrage of adjournments by the Revenue Department since assessee (in most of the stay granted matters) is prohibited from seeking adjournments. 

Even otherwise, this threshold of 20% which is now sought to be imposed is against the earlier instructions issued by the Central Board of Direct Taxes (“CBDT”) as well as the stand of the Revenue Department in stay granted matters before the Apex Court that in fit cases, recovery of tax could be kept in abeyance and in deserving cases stay could be granted on payment of less than 20% of disputed tax demand.  This 20% threshold was introduced by the CBDT by their instruction no. 1914 dated 21.03.1996 (as revised vide O.M. Number 404/72/93-ITCC dated 29.02.2016 and 31.07.2017) while entertaining a belief that the Revenue officers had been passing reasonable orders.  Thus this threshold of 20% is only a number plucked out of the air and has no legal sanctity.  In fact, this amendment seems to be stemming out of the desperate need of the government to meet fiscal targets while causing more harm than good in aligning to its own reformative agenda of making India the “most attractive destination for doing business”.  It is no secret that the Revenue Department is the biggest litigant in India with a low success rate and therefore directing 20% deposit also seems to be counterproductive given the interest cost that it may have to bear. 

The Government also seems to be unaware that the whole purpose of vesting the judicial discretion in the Tribunal was that in an appropriate case, for example where the issues had already been decided in favour of the assessee in the preceding years or where the matter stands covered by the decision of jurisdictional High Court or the Apex Court, the Tribunal was competent to grant stay in recovery proceedings without insisting payment of disputed tax demand.  In the new scheme of things, it would now be incumbent upon the Tribunal to insist on a payment of 20% in every case.  This would result in flood of litigation and already burdened High Courts would be burdened more. 

Time and again, when unreasonable fetters have been imposed by the legislature on the Tribunal's power to grant stay, the higher judiciary has intervened to uphold the principles enshrined in the Constitution of India.  The Apex Court in Venkateshwara Theatre vs. State of Andhra Pradesh observed that just as a difference in the treatment of persons similarly situated leads to discrimination, so also discrimination can arise if persons who are unequals, i.e., differently placed, are treated similarly.  In that context it was held that a law providing for equal treatment of unequal objects, transactions or persons would be condemned as discriminatory if there is absence of rational relation to the object intended to be achieved by the law.  It seems as if the amendment sought by the legislature in first and second proviso to section 254(2A) of the ITA does exactly the same, without shedding any light on the mischief it seeks to remedy.  It treats those assessee's who have a strong prima facie case in their favour with assessee's who do not and therefore may suffer the same fate as the amendment in question in Pepsi Foods (supra).  It also seems to negate the decision of the Delhi High Court in Maruti Suzuki India Ltd. vs. DCIT [TS-699-HC-2011(DELHI)-O] wherein it was held that tax demand ought not to be pressed when the matter is covered in favour of the assessee in its own case for preceding years.  This amendment also seems to interfere with the exercise of judicial discretion vested in the Tribunal under section 254(1) of the ITA as also declared by the Apex Court in Mohammed Kunhi (supra). 

Needless to add that the Government should be well advised against introducing such measures while professing the need to reduce litigation.

The Nuances of Compliances in the New E-Commerce Withholding Tax Provision

The e-commerce market in India is pegged at around $64 billion undertaking an estimated 1 million transactions per day and is expected to be $200 billion by 2027 (https://www.ibef.org/industry/ecommerce/infographic). With the amount of transactions taking place online, the number of e-commerce operators and e-commerce participants are ever increasing.

In a typical e-commerce marketplace model, there are three parties:

a) e-commerce operator;

b) Vendor selling the goods; and

c) Customer purchasing the goods.

Pictorial representation of a typical e-commerce transaction is depicted below:

The above transaction entails following steps:

• The vendor lists his products on the e-commerce operator's platform.
• The customer places an order on the e-commerce platform and makes a payment through any payment gateway or cash on delivery option, as may be convenient.
• The payment flows from the customer to the nodal bank account of the e-commerce operator and the order of the customer is confirmed. In certain cases, particularly in a cash on delivery transaction, the settlement can be made through the collection agent, in which case the payment is made directly to the vendor from the collection agent.
• The seller receives order confirmation and proceeds with the processing of the order.
• The e-commerce operator remits the payment to the seller after adjusting its service fee/ charges/commission payable by the seller to the e-commerce operator.

Proposed withholding provision on e-commerce transactions:

One of the proposals in the Finance Budget 2020 is to introduce a new provision to bring e-commerce players into the withholding tax ambit. The new proposal lays down following:

• the e-commerce operator to deduct tax at the rate of 1% on the gross amount of sale of goods or service or both effected by an e-commerce seller.
• provision to work as a deeming fiction to provide that payments made by customers to the e-commerce sellers would be deemed as amount credited or paid by the platform provider to the e-commerce sellers.
• exception from the withholding tax applicability is provided in case of payments to Individuals/ Hindu Undivided Family (“HUF”), whose gross amount of sales or services or both, through e-commerce operator, does not exceed five lakh rupees and such Individual/ HUF furnishes a PAN

Impact of the proposed provision:

Given the wider scope of this provision, it appears that virtually all transactions undertaken by the e-commerce industry could be covered within the scope of this provision (including digital goods and services).

It is worthwhile to note that there could be certain practical challenges in implementing these provisions, such as discussed below:

• The provisions introduced indicate that once tax is withheld on this transaction, then no other withholding tax would apply on the transaction. The question of what is a transaction can be a larger issue. That is to say, is it the sale of goods/ services on the platform or does it encompass the incidental commission/ advertisement transaction also. If the interpretation is that the transaction includes the incidental commission/ advertisement as well, then should the sellers not be liable to withhold tax on the e-commerce platform going forward? A clarification from the Government on this matter could aid the interpretation of the provision.
• In the trading segment the margins are usually nominal. The rate of tax deduction of 1% is applied on the gross sale value and therefore can result in significant loss in working capital for the vendors. In some cases, where the margin itself is lower than 1%, the vendor will actually have a cash loss. It is relevant to note that the amendments also include a provision, which enable the vendor to apply for a lower withholding tax certificate from the tax authorities and therefore, this opportunity can be made use of in appropriate cases.
• In certain instances, the customer directly pays the vendor for the transactions effected on an e-commerce platform and the platform provider does not facilitate such payments. As these e-commerce operators are required to deduct taxes at 1% on such payments directly paid by customers to e-commerce sellers, the e-commerce operators would essentially have to collect the amount from the e-commerce sellers and deposit such taxes to the Government.  Given that there would be numerous e-commerce sellers registered on the platform, it is going to be highly cumbersome process for the e-commerce operators to reach out to e-commerce sellers and ensure compliance with this proposed TDS requirement.
• The section does not clarify whether the e-commerce operator should be a resident or a non-resident. Therefore, the non-residents are also burdened with this onerous obligation although the income taxable is of the residents. From a practical perspective, it is difficult to expect the non-residents to implement a system to trace such transactions, register with the income-tax department, deduct taxes and ensure compliance. Considering this, the non-residents may even be discouraged to take on board the Indian resident e-commerce players on its platform, which could act as a dampener for the e-commerce growth and further negate the idea of “ease of doing business” in India.
• It is also imperative to consider how tax administrations would initiate proceedings on the non-resident e-commerce operators to ensure compliance.
• The definition of “e-commerce operator” requires such e-commerce operator to be a person responsible for paying to e-commerce participant. There is no clarity as to whether this needs to be established through contractual terms or does it mean that every e-commerce operator would automatically be considered as a person responsible for paying to e-commerce seller for the purpose of this provision.
• On a separate note, similar provisions under GST laws are already in place for e-commerce operators which addresses the issue of tax evasion and introducing a similar provision under income-tax just adds to the compliance burden on the e-commerce players when the need of the hour is to simplify compliance requirements to enable ease of doing business.

Prior to the above provision being enacted, the understanding of the entire eco-system of the e-commerce world, the flow of transaction and what part/ sub-part of the transaction is aimed to be taxed, is critical. Implementation of an ambiguous law will not only pose challenges but also could become stressful exercise for the taxpayers.

[The article was written with inputs from Priya Narayanan (Director) and Anand Agarwal]

Madam FM have a little more Trust!

Introduction

On 1st February 2020 the finance minister presented her second budget. In her maiden attempt she was hampered by lack of time as well as experience. Over a period of time she had displayed firmness, tact in dealing with stakeholders and therefore expectations were high. What she delivered was a mixed bag which disappointed many.

Charitable trusts which hitherto were dealt with kid gloves are now on the radar of every Finance Minister for around a decade. This year trusts received special attention much of which will not please the trustee fraternity. While it addresses some of the issues it increases the compliance burden significantly.

Background of registration of trusts

Under the Income Tax Act (the Act) registration under section 12A/12AA is a mandatory requirement for availing of an exemption under section 11 by charitable institutions. Under the existing provisions such as registration once granted is permanent unless it is cancelled by an order under specific circumstances. Various issues arising therefrom are already the subject matter of litigation before the different fora.

New scheme

 It is now proposed to introduce a new section 12AB to grant registration to the charitable institutions in order to be able to claim exemption under section 11.

As per the proposed provisions, charitable institutions have been divided into 6 categories. These are-

(a)   Those already registered under section 12A/12AA- section 12A(1)(ac)(i)

(b)   those who are yet to commence activities and obtain registration under section 12AB by way of provisional registration-section 12A(1)(ac) (vi)

(c)    those whose provisional registration is about to expire or subsequent to provisional registration they have commenced activities -section 12A(1)(ac)(iii)

(d)   those who have undertaken a modification of their objects which do not conform to the conditions of the original registration-section 12A(1)(ac)(v)

(e)   those whose registration has become inoperative and are seeking to make it operative section 12A(1)(ac)(iv)

(f)     those who are registered under section 12AB and whose registration is due to expire -section 12A(1)(ac)(ii)

Institutions already holding registration category (a)

Institutions having an existing registration under section 12AA or 12A, are also required to make a fresh application for registration on or before 31st August 2020, in order to be eligible to claim exemption under section 11. On receiving such application, the Principal Commissioner of Income Tax (PCIT) or Commissioner (CIT) shall grant registration under section 12AB without making any enquiry.

Institutions yet to commence activity- category (b) and those who commence activity after obtaining registration category (c)

Under the existing law, there is no provision to grant a provisional registration to a newly constituted institution which is yet to commence its activities. This has resulted into denial of registration on account of the activity being unverifiable which is one of the requirements of 12AA. Trusts claim that without a registration they are unable to obtain contributions and without contributions they cannot commence activity - a chicken and egg situation. This has led to litigation. It is now proposed to address this issue, by introducing a concept of provisional registration for a period of 3 years. Upon an application being made by institution for provisional registration, such provisional registration shall be granted by the Commissioner without making a detailed enquiry into the objects/ activities or compliance with any other laws etc. When such provisional registration has been granted to an institution, at least 6 months before the expiry of the said period of 3 years or within a period of 6 months of commencement of its activities, whichever is earlier, the institution is required to make an application for registration under section 12AB.

Institutions who have undertaken modification of objects which do not conform to the conditions of original registration -category (d)

On similar lines to that of section 12A(1)(ab), if after granting of registration the institution amends its objects which are not in conformity with the conditions of registration, by virtue of proposed section 12A(1)(ac), such institution is required to obtain a fresh registration under section 12AB.

Institutions whose registration has become inoperative and are seeking to make it operative- category (e)

Under the existing provisions of section 11(7), a charitable institution is entitled to simultaneously hold registration under section 12A and also an approval for the purpose of section 10(23C) and claim exemption either under section 11 or under section 10(23C) or under both these sections for a particular assessment year.

A significant amendment is proposed by way of insertion of first and second proviso to section 11(7), to provide that the registration granted under section 12A or section 12AA or under the proposed section 12AB, shall become inoperative from the date on which an approval is granted for the purpose of section 10(23C) or section 10(46) {trusts established, or constituted under a Central, State or provincial Act} as the case may be, or from 1st June 2020, whichever is later. In such case, if the institution wishes to claim exemption under section 11, it will have to apply for a fresh registration under section 12AB, which, if granted, would render the approval granted for the purpose of section 10(23C) or section 10(46) inoperative. Thereafter, the institution will be disentitled to claim exemption under those sections.

Therefore, as per the proposed provisions, it appears that now a charitable institution may either opt to be registered under section 12AB and claim exemption under section 11,  or apply for an approval for the purpose of section 10(23C) or 10(46) and claim exemption under those sections.

The intention behind introducing such restriction, even though an institution may fulfil the conditions prescribed under the respective provisions, is unclear and appears to be unfair for institutions engaged in genuine charitable activities.

Further, on strict interpretation of the last part of the second proviso to section 11(7), in the event that the registration under section 12A is subsequently cancelled, whether an institution would again be eligible to claim exemption under section 10(23C) or section 10(46) seems to be a debatable question.

Institutions which are registered under section 12AB and whose registration is due to expire-category (f)

Those institutions that are registered under section 12AB will obtain a registration for a period of 5 years and thereafter it will be renewed for a period of 5 years.

Process of registration under section 12AB or cancellation thereof

In case of institutions already registered or those seeking a provisional registration, it appears that the Commissioner will make only a preliminary verification and grant registration, for 5 years for trusts in existence and 3 years for provisional registration Category (a) & (b)

Regarding all other categories the scope and extent of enquiry is identical to that of section 12AA and does not require any elucidation.

As far as cancellation is concerned the powers of the PCIT / CIT are similar to that set out of section 12AA.

Issues

(a)   It may be noted that under the proposed provisions, there does not seem to be any provision for condonation of delay in making such application on or before the specified dates set out in the section. To illustrate in case of  trust already registered under section 12A/12AA, it seems that  on a failure to make an application on or before 31st August 2020 ( within 3 months from the amendment becoming effective i.e. 1st June2020 , the institution shall not be entitled to get the automatic registration as mentioned above. It will then violate the conditions of 12A disentitling to an exemption under section 11

(b)   There are various time frames are prescribed for making applications under different situations with no leeway for condonation. Similarly, there are various time frames prescribed within which the PCIT / CIT will pas orders. There is no provision setting out a remedy, in case the authority fails to pass an order.

(c)    The term 3 years or 5 years for which provisional or final registration is granted is not precisely defined and may create confusion.

(d)   In case of institutions already holding registration under section 12A or 12AA, the automatic registration as mentioned above is to be granted only for a period of 5 years and such institution shall be required to make a fresh application for registration, at least 6 months prior to the expiry of the said period of 5 years. Considering that the institutions already holding an existing registration under section 12A or 12AA are to be automatically granted registration u/s 12AB without verification of objects, activities etc., it is wondered as to why such institutions are required to make an application in the first place. This would only increase the compliance burden on the charitable institutions as well as the Department. This seems to be in complete contradiction with the object of simplification.

Other amendments / Consequential amendments

Amendments to section 10(23C) which are similar to those in section 12A and 12AB have been proposed.

Amendments similar to section12A/12AB have been proposed to section 80G. In addition, thereto trusts accepting donation are required to file statements of donations with details of donors and now possibly the deduction under section 80G will be allowed only after cross verification with such statements.

A consequential amendment is proposed to section 115TD which levies tax on accredited income.

Comment

The object of these amendments is not understood. While it is true that some unscrupulous elements used trusts as vehicles of tax avoidance, at times tax evasion. However, such elements are prevalent in all areas and the department is armed with more than adequate powers to deal with them.

In an era where more and more faith is placed in the citizen these amendments, are working in the reverse direction. It will be useful to refer to a CBDT Circular no. 7 of 2010 dated 27th October 2010 whereby the approvals under section10(23C) and 80G were made one-time approvals to exist in perpetuity till withdrawn /cancelled. In exactly a decade this is sought to be reversed.

It is well known that charitable trusts, particularly the smaller ones rely on voluntary service. To increase compliance burden on them will be counterproductive. These proposed amendments need a serious relook. If they must continue, they must apply to significantly high thresholds. It is only then that verification /examination will yield results. The government will then be in sync with its motto “sab ka saath, sab ka vishwas”!

Taxing Dividends - A Compliance Nightmare in the making!

Currently, India taxes dividends distributed or declared or paid by any domestic company to its shareholders in the hands of the distributor company in form of Dividend Distribution Tax (DDT) @ 15% (plus surcharge & cess). Such DDT is considered to be a final tax on such dividends and hence, dividend income is exempted in the hands of shareholders (except for additional tax @ 10% for dividend income exceeding Rs. 10 lakhs as per Section 115BBDA).

Globally, dividends are taxed in the hands of the recipient of dividend since it is an income of the recipient and not the distributor. Historically, India also followed this model of taxation. However, for ease of collection of taxes and to relieve the distributor companies from cumbersome process of computing withholding taxes from the income of the recipient, India had introduced DDT model of taxation in 1997. This model again underwent a change vide Finance Act 2002, where an attempt was made to re-direct the taxability in the hands of the recipient. However, on account of the cumbersome withholding process, it was re-introduced in 2003.

One of the primary arguments against DDT is that it brings a parity between recipients of all kinds i.e. the effective tax rate of 20% is applicable on all dividends, whether it is being received by highest or lowest bracket earner. Hence, it is argued that a lot of retail investors in the moderate-income group are disadvantaged by lesser dividend inflow. The abolition of DDT has been debated since a few years now, backed by this argument.

Prior to the Budget, there was a buzz that the Government would take certain steps in this direction. As anticipated, the Government has introduced various amendments in the Finance Bill 2020 (the Bill) whereby, India now moves back to the classical system of taxing dividends i.e. taxing the same in the hands of the recipient. Accordingly, any dividends declared or distributed on or after April 1, 2020 would now be taxable in the hands of the recipient like any other income and not the distributing company at the rates as may be applicable to such recipient.

However, the amendment leaves certain important administrative challenges posed to the companies (especially listed companies) unanswered. It seems unlikely that the government evaluated the volume of investments received by listed companies as against a complicated tax structure in India (Dividend taxability is now governed by various sections based on the status of the recipient i.e. resident / non-resident individual, FII, FPI, foreign company, whether the investment was made in foreign currency, etc.). In addition, since the dividend is now income in the hands of the recipients, non-residents would have access to treaty benefits and hence, apart from the tax rate governed by the Act, the distributor companies shall have to evaluate the treaty benefit eligibility of its recipients.

It is a compliance nightmare for listed companies in the making beginning from determining tax residency as on the date of declaring dividend, residency as per tax treaties to collecting and maintaining documentation of PAN, TRC, etc. Further, compliance with Form 15CA requirement is yet another uphill task. It is also important to note that apart from the voluminous task of determining taxability and complying with Form 15CA requirement, the difficulty also arises from the short window available for listed companies from the date of declaration of dividend to actual payment of the same (As per Section 123 of the Companies Act, the amount of dividend should be deposited in a scheduled bank account within 5 days of declaration and paid within 30 days from declaration).

However, the major anomaly and contradiction within the Act itself is that in certain cases, the withholding rate of tax as prescribed is higher than the rate of taxability of such dividends.

• The provisions are simple and clear in case of resident shareholders. The dividend is proposed to be taxable as per the applicable slab rate while the Bill provides for deduction of tax at source @ 10% with a nominal threshold of Rs. 5,000.
• For non-resident investors, the taxability is governed by Section 115A, which is proposed to be amended so as to tax such dividend @ 20%. However, the withholding is governed by Section 195 and rates are specified for each Financial Year in Part II of First Schedule of respective Finance Act as 'rates in force'. It goes without saying that for the taxation and collection mechanism to work in sync, the rates in force have to be same as the taxability rates.
• Accordingly, for non-residents receiving dividends from Indian companies, tax should be withheld at 20% and this rate should be specifically mentioned in a separate category in Part II of the First Schedule to the Finance Act or the treaty rates, as may be applicable (subject to conditions of providing necessary documents and details like TRC, Form 10F, etc.)
• Here, it is surprising to note that no specific mention is made in Part II of the First Schedule to the Bill for withholding rate of tax on dividend income of non-resident company or non-resident non-Indians. Consequently, unless tax treaty benefit is claimed, such dividend is subject to withholding tax at higher rates (since tax shall be required to be withheld in residual category).

A comprehensive comparative withholding rate chart is given hereunder for all categories of recipients:

Category (as per Part II of First Schedule)	Taxability	Withholding (Part II of First Schedule)
		Category under which taxable	Withholding Tax Rate
Person other than a company
1.     Resident in India	As per applicable slab rate		10%
2.     Non-resident Indian	20%	Investment Income	20%
	20%	Other Income	30%
3.     Non-resident Non-Indian	20%	Other Income	30%
In case of a company
4.     Domestic Company	As per applicable tax bracket	Other Income	10%
5.     Foreign company	20%	Other Income	40%

* Please note that investment income means income where investment was made in foreign exchange

• Ideally, since such dividend is taxable in the hands of non-resident shareholder at a maximum rate of 20%, necessary amendment is required to be made in Part II of the First Schedule at the time of passing the Bill so as to synchronize the rates of taxability and withholding. (It may be noted that necessary amendment has been made in case of mutual funds where Section 196A has been amended to provided that the mutual fund is required to withhold tax @ 20% for making payment to non-resident unit holders).
• Looking at this from the perspective of non-resident recipient of dividends (other than NRI), they are faced with the hassle of providing documents related to PAN, tax residency to avail treaty benefits, Form 10F, etc. If the tax is deducted at a rate higher than 20%, they shall have to file return of income in India and claim refund of the excess tax deducted or forego the excess deduction, depending on the amount of dividend receivable as against the time & cost involvement for furnishing return of income, etc. On one hand, the Bill has tried to ease the compliance burden by providing that non-residents receiving income in form of dividend, interest, royalty or fees for technical services shall not be required to furnish a return of income if the tax is deducted as per provisions of the Act and on the other hand, it contradicts itself by necessitating them to furnish return of income in order to claim refund of excess tax deducted.
• The non-residents (other than NRI) shall have an option of applying for a lower-deduction certificate however, since it depends on tax residence and residence for claiming treaty benefit, it remains to be seen what would be the procedure involved as well as the costs & time factor the investors are looking at.

Before 1997, when the taxability of dividends was in the hands of the recipients, Part II of the First Schedule contained specific entry for withholding of tax in case of non-resident non-Indians as well as foreign companies, which was in sync with the taxing provisions (e.g. 20% in 1996). It is also surprising that when the taxability was shifted to recipients for an intervening period of one year in 2003, Part II of the First Schedule did not give any specific withholding rate and hence, even then the tax was required to be deducted based on the residual category i.e. 30% in case of non-resident non-Indian individuals and 40% in case of foreign companies. However, since the intervening period was only a year, it is unclear whether the intention was to deduct tax at a rate that is higher than its taxability.

In addition, it is very important to note that there is even higher difference between scenario as existed in 2002 and today. The number of foreign investors participating in Indian companies has gone up significantly and so has the compliance and documentation requirement. The time frame for declaration and payment of dividend has also narrowed down to 5 days, as discussed earlier.

In view of the above discussion, it is imperative that the government makes some amendments to the proposals before passing the Finance Act to synchronize the taxability and withholding rates for non-residents (other than NRIs). Further, in view of the administrative and compliance hassle foreseen for listed companies based on the Bill as it is currently drafted, it is also necessary that the government introduces some measures which brings clarity and eases the compliance burden. Failing which, we may again be looking at re-introduction of DDT, like in 2003!

[This article was co-authored by Stuti Trivedi (Senior Manager, K C Mehta & Co.)]

International Tax Proposals in Budget 2020

Ahead of the Budget, the FM had already announced reduction in corporate taxes, which are now aligned with global rates.  Therefore the expectations of the international tax community from the budget were more about removing dividend distribution tax ('DDT'), long terms capital gains tax and measures to improve the ease of doing business in India and effective disputes resolution mechanism.  The Budget 2020 proposes several direct tax proposals for international business community which are summarized below. 

Abolition of DDT

DDT has been abolished and dividends will now be taxable in the hands of shareholders.  Non-residents ('NRs) would now be eligible to claim beneficial rates for taxation of dividends under tax treaties as well as claim tax credit in the home country of taxes paid on dividends.

Broadening the scope of Significant Economic Presence ('SEP')

Finance Act, 2018 had introduced the concept of SEP in 'Business Connection ('BC') in India' wherein SEP has been defined as (i) transaction in respect of any goods, services or property carried out by NR in India exceeding prescribed revenue thresholds or (ii) systematic and continuous soliciting of business activities or engaging in interaction with prescribed number of users, through digital means.  It was not yet operative as the 'revenue' and 'user' thresholds were not notified by the Indian Revenue Authorities ('IRA').  The applicability of SEP provisions has now been deferred to assessment year ('AY') 2022-23 onwards. It is expected that by this time, some global consensus would be reached to adopt a uniform approach by countries in application of a new nexus test and attribution of profits thereto and the fate of unilateral measures such as SEP can then be decided accordingly.

Further, the scope of SEP provisions has been expanded to include systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India, as may be prescribed, whether through digital or non-digital means (earlier this limb was restricted to 'digital means' only).

The SEP test is introduced in the Act and will remain subject to the PE test under the applicable tax treaties. Once global consensus has been reached, tax treaties could be amended to reflect the new nexus rules.  For residents of countries which do not have tax treaties with India, the SEP test could apply once it becomes operational.

Broadening the scope of 'income attributable to Indian operations'

It is proposed to insert Explanation 3A to section 9(1)(i) of the Act to declare that income attributable to operations carried out in India shall include income from:

−  such advertisements which targets a customer who resides in India or a customer who accesses the advertisement through internet protocol address located in India;

−   sale of data collected from a person who resides in India or who uses internet protocol address located in India; and

−   sale of goods and services using data collected from a person who resides in India or who uses internet protocol address located in India.

It is further provided that the above amendment would apply to both SEP cases (from
AY 2022-23) as well as non-SEP cases (from AY 2021-22).  The above deeming provision would give expansive rights to the IRA to attribute income to Indian operations.  However, the practical application of this provision could be challenging and would bring in uncertainty.  Some of the concerns are as follows:  

−  Equalisation levy ('EL') already applies on online advertisement income of a NR not having a PE in India and such payments are then exempt under the Income Tax Act, 1961 (the 'Act') -  therefore, interplay between EL and the abovementioned expanded scope in relation to advertisements that are targeted to Indian customers would need to be examined;

− It could be practically difficult to track the internet protocol address of the user and determine nexus and attributable income to Indian operations;   

−  Keeping track of data collected from person in India or its use could be administratively cumbersome and have additional cost burden; further, whether Government intends to include only cases where direct connection with data collected from person in India could be established or even indirect links to such Indian data is included, is unclear and may create attribution issues; and

−  Inter-play between profit attribution rules as prescribed in Article 7 (Business Profits) of tax treaties for PEs in tax treaty cases and above expanded scope would need to be examined.

It is widely anticipated that the reason for introduction of the above provision could be to send a clear message to the global community about India's taxing right over such income and to leverage on the same during the OECD Pillar 1 discussions on the new nexus and profit allocation rules.

Safe harbour Rules ('SHR') and Advance Pricing Agreement ('APA')

It is proposed to cover cases relating to determination of profits attributable to a BC within SHR and APA. This is a good move by Government and would help in reducing the tax disputes and also provide certainty to the taxpayers. It is expected that Government would come out with further clarifications in this regard.

Exemption for a NR from filing tax return in India

NRs earning only royalty/FTS will now be exempt from filing tax return in India provided tax has been deducted as per the rates provided under section 115A of the Act.  While this is a welcome move, there is uncertainty about NRs claiming the benefit of lower rates under a tax treaty and availing this exemption. This appears to be intentional, so that IRA has an opportunity to verify whether the claim for treaty benefits is indeed admissible (keeping in mind the increased focus on substance requirements, beneficial ownership etc).  Further, whether transfer pricing compliances will need to be done for related party transactions or not will still need to be evaluated.

Alignment of the Act with Multilateral Instrument ('MLI')

India has signed the MLI which will be applied to covered Indian tax treaties with effect from financial year ('FY') 2020-21.  The MLI has a preamble text which provides the objective to be as follows: 'intending to eliminate double taxation with respect to taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of any other country or territory).  The similar text is now proposed to be added in section 90(1)(b) of the Act to align the intent of entering into Indian tax treaty with that of the MLI.

Broadening the scope of the definition of 'Royalty' under the Act

Currently, the definition of 'royalty' under the Act excludes consideration for the sale, distribution or exhibition of cinematographic films.  However, since a similar exclusion in the definition of 'royalty' is absent in most of India's tax treaties, it is proposed to remove the above exclusion from the definition of 'royalty' under the Act to align with tax treaties.  Accordingly, income earned by NRs from sale, distribution or exhibition of cinematographic films may now fall under the Indian tax net as royalty.

Withholding tax (WHT) rates on certain interest income of NRs

The sunset clause for availing concessional WHT rate of 5 percent on interest paid to NRs on specified foreign currency / rupee denominated borrowings under section 194LC of Act has been extended from 1 July 2020 to 1 July 2023.

Tax Collected at Source (TCS) on sale of goods

It is proposed that a seller of goods (having business turnover exceeding INR 100 million in preceding FY) who receives aggregate consideration in excess of INR 5 million during the year from a buyer shall be required to collect TCS from the buyer at the rate of 0.1 percent (in non-PAN / Aadhaar cases at the rate of 1 percent).  This provision is very expansive though with a flexibility to exclude certain persons notified by IRA.  However, no exemption is currently provided to NRs from applicability of this provision.

The direct proposals for NRs are a mixed bag with some proposals well intended whereas some other proposals especially dealing with SEP, deemed source rule and applicability of TCS are likely to create uncertainty in terms of complying with Indian laws. The Dispute Settlement Scheme announced by the FM will also bring huge relief to taxpayers who are keen to resolve their long pending cases in India.

[This article was co-authored by Ajay Jain (Manager, Deloitte Touche Tohmatsu India LLP)]

Union Budget 2020: Taxing the Shareholders on Dividend Income

1. Preamble 

1.1. The Hon'ble Finance Minister through Union Budget 2020 has proposed that dividends declared by domestic companies to shareholders would not be subjected to Dividend Distribution Tax ('DDT') under section 115-O of the Income Tax Act ('the Act'), but would be taxable in the hands of the recipient shareholders at the applicable rates. 
1.2.         Under the proposed regime:

• DDT will not be required to be made (under section 115-O of the Act) from Assessment Year ('AY') 2021-22 relevant to Financial Year ('FY') 2020-21, on dividends declared, distributed or paid by domestic companies to shareholders;
• Section 115BBDA which taxes dividend income in excess of Rs. 10 lakhs in the hands of shareholders at 10% shall not be applicable and consequentially the dividend income will be taxable based on the shareholders tax brackets;
• Deduction will be allowed under section 57 of the Act in respect of interest expense and such deduction shall not exceed 20% of the dividend income;
• The domestic company declaring dividend will be required to withhold tax on resident payees at 10%  (under section 194) where dividend is paid in excess of Rs. 5,000 to a shareholder and non-resident payees at the rate of 20% or as mentioned in the Double taxation avoidance agreement ('DTAA'), whichever is lower;
• Section 80M has been inserted to remove the cascading effect of tax on dividend income received by a domestic company distributing dividend from another domestic company. 

1.3. The present provisions levy tax on dividends at a flat rate of 17.47% (effective tax rate 20.56% once grossed up) on the distributed profits irrespective of the marginal rate at which the recipient is otherwise taxable. These provisions are considered iniquitous & regressive.  The Government accordingly proposes a scheme of taxation wherein dividend income is taxed only in the hands of shareholders and not the Company distributing such dividend. The Government has explained the rationale for the proposed scheme of taxation in the Memorandum to the Finance Bill, 2020 by stating “the present system of taxation of dividend in the hands of company/ mutual funds was reintroduced by the Finance Act, 2003 (with effect from the assessment year 2004-05) since it was easier to collect tax at a single point and the new system was leading to increase in compliance burden. However, with the advent of technology and easy tracking system available, the justification for current system of taxation of dividend has outlived itself.” Hence, the government has proposed to move the tax incidence on dividend directly in the hands of the shareholders. 

2. Assessing the impact of the proposed regime for taxing dividends 

The effective tax cost on dividend income will increase for resident shareholders 

2.1. Under the new regime, the entire dividend will be taxable and the exemption threshold of Rs. 10 lacs as per the earlier regime will not be available. Moreover, the higher surcharge with increasing income slabs could significantly increase the tax cost. For example, effective tax rate on a dividend of Rs. 30 lacs for a taxpayer whose income exceeds Rs. 5 crores would be 42.74% as compared to 30.06% in the earlier regime. An illustrative table is as under: 

Particulars	Existing					Proposed
	Distributable Surplus	DDT paid by Company - S. 115-O	Tax borne by Shareholders - S. 115BBDA	Total Tax Cost	Effective Tax cost	Tax Cost - applicable rate	Effective Tax Cost	Increase in Tax Cost
	(A) = 30L x 120.56%	(B) = (A) - 30L	(C) = 20L x 10% (Note 2)	(D) = (B+C)	(E) = D/30L	(F) = 30L * G	G	H = G - E
Where Total income including dividend
exceeds Rs. 10,00,000 but not 50,00,000	36,16,800	6,16,800	2,08,000	8,24,800	27.49%	9,36,000	31.20%	3.71%
exceeds 50,00,000 but not 1,00,00,000	36,16,800	6,16,800	2,28,800	8,45,600	28.19%	10,29,600	34.32%	6.13%
exceeds 1,00,00,000 but not 2,00,00,000	36,16,800	6,16,800	2,39,200	8,56,000	28.53%	10,76,400	35.88%	7.35%
exceeds 2,00,00,000 but not 5,00,00,000	36,16,800	6,16,800	2,60,000	8,76,800	29.23%	11,70,000	39.00%	9.77%
exceeds 5,00,00,000	36,16,800	6,16,800	2,84,960	9,01,760	30.06%	12,82,320	42.74%	12.69%

Note:

1) The distributable surplus would be increased in the hands of the Company, which could result in a higher dividend declaration (e.g. say Rs. 36,16,800 as compared to the Rs. 30,00,000). Even in such a scenario the net post tax funds available in the hands of the shareholder would be lower (e.g. Rs. 36,16,800 less 31.20% * 36,16,800 i.e. Rs. 24,88,358) as compared to the earlier regime (e.g. Rs. 36,16,800 less Rs. 824,800 i.e. Rs. 27,92,000).

2) The effective tax rate is inclusive of surcharge at the rate applicable and cess. 

The effective tax cost on dividend income will reduce for foreign shareholders. 

2.2. Under the proposed regime, the non-resident taxpayers will have an option to offer income earned by way of dividend under section 115A/115E of the Act at 20% (plus applicable surcharge and cess). This is subject to relief under section 90(2) of the Act wherein a tax rate more beneficial as per the DTAA could be applied. The tax treaty rates for withholding tax on dividend for the top 5 jurisdictions from which India attracts FDI are tabulated below: 

Particulars	Individuals	Companies holding less than 10% voting stock	Companies holding more than 10% voting stock but less than 25%	Companies holding 25% or more voting stock
United States of America	25%	25%	15%	15%
Mauritius	15%	15%	5%	5%
Japan	10%	10%	10%	10%
Netherlands	10%	10%	10%	10%
Singapore	15%	10%	10%	15%

2.3.         In scenarios, wherein the beneficial tax rate of 5%-15% can be adopted by non-residents, the tax cost on dividends would be significantly lower than DDT (effective tax rate of 20.56%). Further, the controversy of whether the non-resident taxpayer will be entitled to claim Foreign tax credit ('FTC') in their country of residence is also put to rest considering that the DTAA's entered into by India allow for credit on taxes paid in India to be claimed (subject to the limitation of benefit clauses). In order to claim the treaty benefit, the recipients will need to furnish a tax residency certificate and/or declaration in Form 10F. Also, as required by section 206AA of the Act, the non-residents shall furnish their Permanent Account Number ('PAN') to the person responsible for deducting such tax, failing which tax shall be deducted at higher of i)  rates specified in relevant provision of the Act ii) rates in force or iii) 20%. 

No dual taxation on dividends received by a domestic company from another domestic company 

2.4. Section 80M has been inserted to remove the cascading effect of tax on dividend income received by a domestic company from another domestic company. The proposal provides that where the income of a domestic company includes dividends from any other domestic company, there shall be allowed a deduction of the amount of dividend received and distributed to its shareholders upto 1 month prior to due date for filing of returns. 

2.5. It should also be noted that this relief is available even where the company opts for the concessional tax rate regime (under section 115BAA and section 115BAB).

 2.6. An illustration is provided below for a better understanding of the above provisions: 

In the books of Company A:

Particulars	I	II	III
Dividend received by Company A from Company B	100	100	100
Less : Expenses	Nil	Nil	10
Gross Total Income	100	100	90
Dividend Distributed to its shareholders	100	90	100
Deduction under section 80M claimed by Company A	100	90	90

Note: To claim deduction under section 80M, Company A has to distribute dividend on or before the due date i.e. a date of one month prior to the date for furnishing return of income under 139(1). 

Dividends from overseas investments will have a cascading tax effect on distributions to ultimate shareholders 

2.7. The dividend income earned by a domestic company from a foreign company is taxable under the head Income from other sources taxable at 29.12%/34.94% (at highest tax rates). Further, the dividend income in which it holds 26% or more of the equity share capital is taxed at 17.472% (under section 115BBD).  In these instances, the deduction under section 80M will not be available in respect of the dividend distributed by the domestic company to its shareholders, which will further be taxed at applicable rates. Accordingly, the effective cost is expected to go high owing to no deduction and cascading effect on dividend earned by domestic companies from foreign companies. 

Potential controversies expected in relation to deductibility of interest expense 

2.8. Deduction will be allowed under section 57 of the Act in respect of interest expense and such deduction shall not exceed 20% of the dividend income. The said interest expense incurred in relation to dividend income earned would be simple to identify if a specific borrowing is availed to make investments which have yielded dividend income. However, controversies are likely to arise in following scenarios:

• Does sufficient nexus exist between borrowings and investment made;
• Where the company has sufficient own funds together with borrowings; the tax authorities could contend that the investments were made out of own funds and no part of interest expenditure is attributable to earning dividend income. 

2.9. It would help if the tax authorities provide appropriate guidance in order to avoid controversies similar to those that exists under section 14A.  It will be worthwhile to note that section 14A will become redundant in the context of investment income streams being Dividend, Capital Gains or Interest which are now taxable. 

2.10. Further, the rationale for restricting deductibility towards Interest at 20% of dividend income is unclear. In scenarios where borrowed funds are utilized to finance investments in equity and preference shares to earn dividend income, the proposal to allow only 20% of the dividend income as Interest expense would be counter to the economic principles requiring the dividend income to service the interest expenses. 

Taxation of deemed dividend arising out of Intra group financing transactions 

2.11. The taxation of deemed dividends (under section 2(22)(e)) in the earlier regime involved a DDT at 30% (plus applicable surcharge and cess). However, in the proposed regime, the dividend will be taxed in the hands of the shareholders at applicable rates. The same could be an opportunity to corporate groups to explore intra-group financing models. Consider an illustration: 

Company A, a holding company has unabsorbed depreciation and business losses in the current financial year. Company B, it subsidiary is a profit making entity and wishes to declare dividend to its Holding company A. In this scenario, the dividend earned by Company A can be set-off with unabsorbed depreciation/current year business losses. In the earlier regime, Company B would have been required to pay a DDT @ 30%, while in the proposed regime there would be no tax since Company A (being the shareholder) will offset the losses with the dividend income earned.

3. Managing the taxes 

3.1. In conceptualising the tax management strategy, the corporate's tax head would need to consider the following:

• Declaring a dividend prior to 31.03.2020 in light of the tax cost under the existing regime being more beneficial to domestic investors; The same would need to be balanced with the cash flow considerations since the tax remittances (excluding the 10% withholding tax) under the new regime is spread over the advance tax instalments;
• Exploring buy-back as an option for higher shareholder returns; since the effective India tax cost on buy-backs is 23.296% on the net gains, which is lower than the tax on dividend income;
• Evaluating alternative financing instruments (equity vs. debt) & re-deployment of funds accumulated in overseas subsidiaries (in case of Indian MNCs);
• Evaluating the adoption of non-corporate entity structures (e.g. limited liability partnerships)  since profit repatriations in case of such entities are tax-free;
• Introducing appropriate compliances processes to track the tax deduction provisions including obtaining declaration of no permanent establishments and tax residency;
• Keeping a close watch on intra-group financing arrangements. 

3.2. In conclusion, India could also consider adopting the dividend imputation form of taxation to make the effective cost for domestic and foreign shareholders at par.  Under the proposed regime closely owned businesses would look to avoid the corporate entity structure in light of a significant erosion of the profits earned by the stage it reaches their hands.  The dividend imputation method reduces or eliminates the tax disadvantages of distributing dividends to shareholders by only requiring them to pay the difference between the corporate rate and their marginal tax rate. Some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. The imputation system effectively taxes distributed company profit at the shareholders' average tax rates. The countries that have adopted dividend imputation form of taxation include Australia, New Zealand which have complete imputation system. Chile, Canada, Korea and UK have adopted partial imputation systems. 

Disclaimer: The views expressed in this article are the personal views of the authors. The views / the analysis contained therein do not constitute a legal opinion and is not intended to be an advice. The authors may be reached at vishnu@sduca.com, arvind@sduca.com & ruchiagarwal@sduca.com. 

[The article is co-aurthored by CA. Arvind S (Singhvi Dev & Unni LLP) and CA. Ruchi Agarwal (Singhvi Dev & Unni LLP)]

Comments / Suggestions in Respect of certain Tax Proposals in Finance Bill, 2020

 

Section	Amendment proposed	Comments	Suggestions
115-O, 115R, 10(34), 10(35) & other related sections	Existing provisions providing for payment of tax by domestic companies and mutual funds on declaration of dividend/income are proposed to be changed to provide that dividend/income shall be chargeable in the hands  of shareholders/ investors at the rate of tax applicable in their cases.	The system of payment of tax by the companies was initially introduced vide Finance Act 1997 and the reason as stated was “The existing method involves a lot of paper work. There have also been demands that tax on dividends should be abolished as it tantamount to double taxation, once in the hands of the company and again in the hands of shareholders.” In this background rate of 10% was provided at that time which has subsequently changed to 12.5 % and 15%. The argument given in the Memorandum for change in the system now is that same rate for all assesses is iniquitous and regressive.	Considering the nature of the dividend income, which is in the nature of distribution of the profit after payment of tax by the company and also the background in which provisions of section 115-O etc. were inserted even if the system is to be changed rate of tax should not be more than 20% as is applicable in case of non-residents and foreign companies in terms of section 115A of the Act apart from the fact that in their cases tax rate may be still lower as per respective DTAA. Changed system will only benefit non-residents and foreign companies and is against the interest of residents and therefore, same is not justified considering the present rate of taxation which goes in case of residents upto 42.74%.
57	Proviso is being inserted in section 57 of the Act to provide that deduction will be available against the dividend income only of interest expense and that too upto 20% of dividend income.	As a matter of principle and also in terms of clauses (i) and (iii) of section 57 of the Act, any expenditure laid out or expended wholly and exclusively for the purpose of earning income is allowable deduction. Therefore, imposing an arbitrary limit of 20% is unreasonable and also contrary to the stand of the department for the purpose of disallowance u/s 14A read with Rule 8D of Income Tax Rules, wherein whole of the direct expenditure, proportionate interest cost and also administrative expenditure was considered to be relatable to dividend income.	Normally the dispute in regard to allowability of expenditure arises in case of business entities, particularly companies. The limit provided in section 57 will give rise to lot of litigation and generally it may be claimed that expenditure is being incurred for the purpose of business only and not for the purpose of investment and therefore, deduction is allowable u/s 36(1)(iii) or 37 of the Act. It is suggested that in order to avoid litigation following provisions should be made:- 1.       In case the expenditure is directly related to earning of dividend income same should be fully deductable u/s 57 to the extent of dividend income. In other words, benefit of loss will not be available. 2.       In case the expenditure is not directly related to investment or earning of dividend income, expenditure should be allowable in terms of section 36(1)(iii)/37 of the  Act.
Rate of tax applicable to individuals	As against standard rate of tax provided in Part III of the First Schedule of Finance Bill , section 115BAB is being inserted to provide an option to pay  tax at the lower rate as per the schedule provided therein, subject to the condition that deductions/ exemptions available to the assesses will not be allowed.	Concessional rates provided in section 115BAB are beneficial only in the cases where deduction is being claimed only to the extent of Rs.2 lakh, which is the deduction normally claimed by assesses u/s 80C or u/s 80CCD/80D. Normal rates will continue to be beneficial in all other cases where higher deduction is claimed.	Providing an option will create lot of confusion to each of the assessee and does not appear to be providing substantial benefit to anyone. It is therefore, suggested that lower rates provided in section 115BAB should be applicable to all the assesses and few deductions like HRA u/s 10(13A), LTC u/s 10(5) may be withdrawn, since general perception is that above deductions are not genuinely claimed in many cases. This will make the system simpler.
17(2)(vii)& (viia)	Clause (vii) of section 17(2) is being substituted to provide that employee's contribution during the year to Recognized provident fund, National pension Scheme and approved Superannuation Fund  in excess of Rs.7.5 lakh is chargeable as perquisite. Clause (viia) provides for taxability of interest or dividend credited to the account of the employee to the extent it relates to amount taxable in terms of clause (vii).	Reasoning being given for taxability of the contribution that same does not suffer tax at any stage is not legally correct. Withdrawal from Superannuation fund as well as pension is chargeable to tax, except in the cases and to the extent provided in section 10(13) of the Act. Withdrawal from NPS is also chargeable to the extent of 60% as per Section 10(12A). PF is also exempt subject to certain conditions.   When there are limits for contribution to each of the fund, there is no rationale to impose an overall limit only for the reason that certain employees are able to structure their remuneration package to avail maximum advantage.   It has also not been provided that how the limit of Rs.7,50,000/- will be determined with reference to each of the funds.	Instead of imposing an overall limit, it may be provided that :- 1.       In case of employees drawing salary beyond a particular limit, employer's contribution will be exempt upto 10% instead of general limit of 12%. 2.       In case of above referred employees contribution made by the employer to NPS will be taxable in the year of contribution. 3.       If required, percentage of contribution to superannuation fund in case of such employees can also be reduced. 4.       Interest credited to the account of employee should continue to be exempt, subject to the percentage notified. This will simplify the procedure and will bring the desired result without causing difficulty to low paid employees. In the alternative it should be specifically provided that amount to the extent already taxed either as contribution or as interest is not taxable at the time of withdrawal so as to avoid double taxation.
6	Sub-section (1A) is being inserted in section 6 to provide that an individual, being a citizen of India, shall be deemed to be resident of India if he is not liable to pay tax in any other country by reason of his domicile or residence.  It would mean that the person will become resident in India in such a case and on that basis his global income will become taxable.	As per amended provision world income of a citizen of India residing outside India will be taxable in India. As per clarification issued by CBDT dated 02.02.2020 income earned by bonafide workers in other countries, including in middle east is not taxable in India unless it is derived from an Indian business or profession.  As per the law world income is chargeable to tax in case of resident and only in the case of 'Resident but not Ordinarily Resident' the income earned outside India is chargeable only if business is controlled from India.	It is being clarified by the government officials in budget meetings that intention is not to allow Indian citizens to pay tax on the income earned from India at a lower rate applicable to non-residents. In case it is the intention, separate rate of tax can be provided for non-resident citizens of India which can be same as is applicable to residents of India.
254	It is being provided by way of amendment in section 254 of the Act that Tribunal will grant stay of demand only if an amount not less than 20% of the sum payable has been paid or security has been furnished for the equivalent amount. It is further being provided that Tribunal shall not have power to extend stay beyond 365 days.	It is unreasonable and unjustified to encroach on the discretionary power of a judicial authority.  Therefore, amendment providing for condition of stay needs to be deleted.   Further, period of 365 days which was already there has been creating problem to the assesses as for many reasons Tribunal is not able to decide appeal within the aforesaid period for no fault of the assessee and the assesses have been approaching the High Court to seek stay beyond 365 days.	Amendment providing for the condition of 20% of demand should be withdrawn.   In case the amendment is not withdrawn, it may be provided that payment already made by the assessee should be considered for determining 20% of the demand raised on assessment.   Restriction of 365 days for extending the stay should also be deleted and it should be left to the discretion of the Tribunal to extend the stay in justifiable cases. It will avoid unnecessary harassment and cost to assesses of approaching the High Court for the extension of stay.
206C	By way of insertion of sub-section (1G) it is being provided that an Authorised Dealer shall collect tax at the rate of 5% from the person who makes remittance under Liberalised Remittance Scheme of RBI. Similarly, tax is to be collected by a travel agent who receives the amount from the buyer of overseas tour programme package.	Provision for collection of tax at source of 5% from such payments is unreasonable and unjustified.  Remittance under LRS is made by the resident either to his children for various purposes or by a non-resident Indian who has been inherited the property makes the remittance to himself. These are the amounts on which either tax has already been paid or tax is not payable.   There is no rationale for collecting tax even on overseas tour packages. Same represents the expenditure incurred by a person out of his tax paid income.	Instead of providing for collection of tax at source a mechanism for reporting of transactions or of declaration by the concerned person giving his PAN and other particulars should be introduced as is there presently in regard to foreign remittances vide Form Nos. 15CA and 15CB. Collecting tax and refunding the same subsequently is neither advantageous to the government nor to the assesses and it will lead to unwarranted work on the tax collector as well as on the government and harassment to the persons who had to make payment of the tax which is not payable.