EY Tax Alert

1 May 2015

EY Tax Alert Key direct tax amendments to Finance Bill 2015

Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor.

The Indian Finance minister (FM) had presented Finance Bill, 2015 (FB 2015), as part of the Union Budget 2015-16, to parliament on 28 February 2015. FB 2015 contained a number of proposals to amend the Indian Tax Laws (ITL). Having regard to the representations made by various stakeholders on the adverse impact of various proposals, or to correct certain anomalies, amendments have been made to FB 2015 at the enactment stage. This Alert summarizes certain significant direct tax amendments to FB 2015 which now have been passed by the Lok Sabha (the lower house of Parliament).

Key direct tax amendments to FB 2015

proposed in the FB 2015. The proposed regime provides that: ►

In the case of an “eligible investment fund”, the fund management activity carried out through an “eligible fund manager” acting on behalf of such fund will not constitute business connection in India.

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An eligible investment fund will not be a resident in India merely because the eligible fund manager undertakes fund management activities in India.

1. Change in the test of residency for foreign companies Under the ITL, a foreign company becomes a resident of India if, during the year, its control and management is situated wholly in India. The FB 2015 had proposed to amend this rule to provide that a foreign company will be treated as a resident of India if its place of effective management (POEM) is in India at any time in that year. There were concerns from various stakeholders on the use of the phrase “at any time” as it could have an adverse impact on foreign companies where only one board meeting is held in India. Addressing such concerns, the FM has deleted the phrase “at any time”. Therefore, for the tax year 201516 onwards, a foreign company will be regarded as a resident in India if its POEM in that tax year is in India. POEM continues to be defined to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made. This is a welcome amendment.

2. Relaxation for certain offshore sovereign funds Under the ITL, income of a nonresident (NR) is taxable in India if it arises, inter alia, through a business connection in India. Presence of a fund manager in India may create a business connection/taxable presence in India for the overseas fund and lead to income of the fund being taxable in India. Such presence may also trigger exposure of creating residency of the fund in India on the basis of its control and management or POEM in India. In order to facilitate location of offshore fund managers in India, a specific regime was

Offshore fund and the fund manager are required to satisfy certain conditions to be eligible for the proposed regime. Some of the conditions to be satisfied by the offshore fund were: ►

The fund has a minimum of 25 members who are, directly or indirectly, not connected persons;

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Any member of the fund along with the connected persons shall not have participation interest, directly or indirectly, in the fund exceeding 10%;

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Aggregate participation interest, directly or indirectly, of ten or less members along with their connected persons in the fund, shall be less than 50%.

As per the amendment, the above three conditions will not apply in case of investment funds set up by the Government of foreign state or the Central Bank of a foreign State or a sovereign fund and such other funds as may be notified by the Government of India (GoI) and subject to fulfilment of conditions as may be specified. Additionally, it has been provided that the special regime shall be applied in accordance with guidelines and in such manner as the administrative board may prescribe.

3. Tax incentive benefits extended to states of Bihar and West Bengal ►

FB 2015 proposed benefit of enhanced additional depreciation from 20% to 35% in respect of new plant and machinery

acquired and installed during specified period for setting up manufacturing units in the notified backward areas of State of Andhra Pradesh or State of Telangana. The Amendment extends the benefit also to such units set up in notified backward areas of the State of Bihar and State of West Bengal. ►

Additionally, FB 2015 proposed the benefit of investment allowance @15% of the amount of investment in new plant or machinery acquired and installed during specified period for setting up manufacturing units in the notified backward areas of State of Andhra Pradesh or State of Telangana subject to certain conditions. The Amendment extends similar benefit to such units set up in notified backward areas of the State of Bihar and State of West Bengal.

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The 1993 Scheme laid down the tax treatment on GDRs, as per which, amongst others, ►

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However, the 2014 Scheme is silent on the aspect of tax treatment. ►

In order to clarify the tax implications on redemption of GDR into shares of a listed company, and thereby, to codify the contention of the 1993 Scheme, the ITL is proposed to be amended to provide that: ►

4. Global Depository Receipts (GDRs) ►

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The ITL provides for a concessional tax rate for NRs on income earned by way of dividends on, and by way of capital gains from transfer of, GDRs purchased in foreign currency. Further, the ITL exempts capital gains on transfer of GDR from one NR to another NR outside India, and on conversion of GDR into shares. Earlier, GDRs were governed by “Issue of Foreign Currency Convertible Bonds and Ordinary shares (through depository receipts mechanism) Scheme, 1993” (1993 Scheme). The scheme was limited to issue of Depository Receipts (DRs) based on the underlying shares or foreign currency convertible bonds of a listed Indian company. With a view to liberalize, the GoI notified a new Depository Receipts Scheme, 2014 (which replaced the 1993 Scheme on GDRs). Under the new scheme, GDRs can be issued against securities of listed, unlisted or private or public companies against underlying securities.

Cost of acquisition post redemption of GDR into shares will be the price prevailing on the recognized stock exchange on the date of advice of redemption Period of holding post redemption of GDR into shares will be reckoned from the date of advice of redemption.

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The period of holding of shares will be reckoned from the date on which a request for redemption is made; and The cost of acquisition of shares will be the price of such shares prevailing on any recognised stock exchange in India on the date on which a request for redemption is made.

The amendment is limited in its implications to redemption of GDRs issued by listed company.

5. MAT for foreign companies The subject of levy of Minimum Alternative Tax (MAT)[1] @ 18.5%[2] on a foreign company which has no business presence in India is currently sub-judice before the Indian Supreme Court. With a view to mitigate the rigour, FB 2015 proposed to provide relief to Foreign Institutional Investors (FIIs), but effective from tax year 2015-16, by excluding certain categories of capital gains from the purview of MAT for FIIs. [1]

Computed with reference to ‘book profit’ as per Profit & Loss Account subject to specified upward and downward adjustments [2]

Plus applicable surcharge and cess

On account of proposed amendment, a larger controversy which arose was whether, all foreign companies (other than FIIs) as also income of FIIs from sources other than capital gains will continue to be liable to MAT in future years. With a view to clarify the tax position as applicable to foreign companies, the amended FB 2015 now provides that, in the following cases, the specified income of foreign companies will be excluded from the purview of MAT from tax year 2015-16 onwards. Consequently, corresponding expenses shall also be excluded while computing MAT.

6. Deferment of MAT applicability to Real Estate Investment Trust (ReIT) / Infrastructure Investment Trust (InvIT) (Business Trust) ►

The ITL as proposed to be amended by FB 2015 provides for special tax regime on transfer of shares by sponsor of Special Purpose Vehicle (SPV) to a Business Trust (ReIT) in exchange of units allotted by said trust and subsequent transfer of units of Business Trust. While at the stage of exchange of shares against units of Business Trust, sponsor enjoys full exemption from capital gains under the normal provisions of the ITL, subsequent transfer of units of Business Trust will enjoy preferential tax treatment at par with tax treatment applicable to the listed securities under the ITL.

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Concerns were, however, raised by sponsor (being company) on prospects of levy of MAT applicability at the stage of exchange of shares against the units allotted by the Business Trust. The concern was all the more valid considering that it would impact cash flow without realization of gain. There was also concern of levy of MAT at the stage of transfer of units of business trust.

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Addressing the concerns, the amendment now provides for deferment of MAT applicability to the stage of transfer of units by the sponsor. The scheme proposed by the Amendment Bill provides as under:

a. The capital gains income (whether long term or short term) arising on transactions in securities[3] , if such income is credited to Profit and Loss account and tax payable on such capital gains income under normal provisions is less than the MAT rate of 18.5%. b. Interest, royalty or fees for technical services chargeable to tax, if such income is credited to Profit and Loss account and tax payable on such incomes under the normal provisions is less than the MAT rate of 18.5% The FM also clarified in the Parliament that assessments for past years will be concluded as per the outcome of judicial process. While the intent to provide relief is clear, the language may still provide some uncertainty – more particularly for other incomes earned by foreign companies from India liable to tax at lower than MAT rate.

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[3]

Definition of ’securities’ is borrowed from Securities Contract Regulation Act. There is currently a debate whether shares of a private company can be considered as ‘securities’

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There will be no MAT levy on gain on transfer of shares of SPV to a Business Trust in exchange of units allotted by that trust. Such gain is considered by the Amendment Bill to be notional gain. There will be no MAT levy on gain from any change in carrying amount of units in the books of sponsor as a result of restatement of values. The actual gain on transfer of units of Business Trust which may have been recorded in the books by reckoning the

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carrying value of units in books will also be ignored for the purpose of computation. Similar adjustment is provided in MAT computation, on principles, if there is any loss incurred at the stage of exchange of shares, or as a result of restatement of value, or at the stage of transfer of units. However, there will be MAT levy on amount of gain, at the stage of transfer of units, such that the gain is computed on the basis of difference between the sale price of units and cost of shares of SPV (as were exchanged with the units of Business Trust) or being the difference between sale price of units and carrying amount of shares in the books of sponsor at the time of exchange of such shares against units, if such shares were carried at a value other than the cost. Similarly, the loss which is found to have been incurred by the sponsor when transfer price of units is compared with the cost of original shares, such loss is considered as deductible loss in the computation of book profit for levy of MAT.

7. Amendments to align ITL with ICDS The GoI notified Income Computation & Disclosure Standards (ICDS) on 31 March 2015, effective from tax year 2015-16 onwards, to be complied by all taxpayers following mercantile method of accounting while computing income under the heads “Profits and gains of business or profession” or “Income from other sources”[4] . Certain provisions of ICDS did not align with provisions of the ITL. Hence, the amended Bill proposes to modify some provisions of ITL as follows:a. Subsidy/Grants – ICDS VII relating to Government grants deals with treatment of government grants. It provides for recognition of such grants either by way of reduction from cost of depreciable asset or as income over the periods necessary to match the related costs. [4]

Refer EY Tax Alert dated 2 April 2015 ‘Indian Government notifies 10 Income Computation & Disclosure Standards effective from tax year 2015-16 onwards’

Doubts had arisen whether it is permissible as per the ITL to recognize a grant which is related to non-depreciable asset of capital nature, as taxpayer’s income. The amended Bill proposes to provide that assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the GoI or a State Government or any authority or body or agency, in cash or kind, to the taxpayer, shall be taxable as its income. However, subsidy/grant/reimbursement which is taken into account for determination of ‘actual cost’ of depreciable assets shall not be treated as income. b. Borrowing costs – ICDS IX provides for capitalisation of borrowing costs in respect of qualifying assets viz. tangible/intangible assets and inventories[5]. The ITL provides deduction in respect of all borrowing costs except when they are incurred for acquisition of an asset ‘for extension of existing business or profession’. The condition of acquisition of asset ‘for extension of existing business or profession’ for disallowance of borrowing costs under the ITL resulted in disharmony with ICDS since ICDS does not have this condition. The amended Bill proposes to omit the condition of asset acquisition ‘for extension of existing business or profession’ for disallowance of borrowing cost to align the ITL with ICDS. c. Revenue recognition – There is an apprehension that application of some ICDS like Revenue Recognition or Provisions, Contingent Liabilities and Contingent assets may result in accelerated recognition of income for tax purposes though the same may not be recorded in books of account as per applicable GAAP. It is possible that such income may eventually be found to be [5]

But only those inventories that require period of 12 months or more to bring them to saleable condition

irrecoverable. While the ITL provides bad debt deduction for debts which are written off as irrecoverable in accounts, it would be difficult for taxpayers to claim bad debt deduction for income which is irrecoverable but hitherto not recognized in the books.

Income and Assets (Imposition of Tax) Bill, 2015 recently introduced in Indian Parliament and which is under its consideration. ►

In order to avoid duplicated furnishing of ROI in respect of reporting the same foreign asset by legal as also beneficial owner, the amendment excludes beneficiary of foreign assets from obligation of disclosure in or furnishing of ROI if income from such assets is includible in hands of legal owner of such asset in accordance with provisions of the ITL.

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The expressions ‘beneficial owner’ and ‘beneficiary’ are now defined.

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The provisions will be effective from 1 April 2016 and will apply from tax year 2015-16.

The amended Bill provides that such debt taxed as per ICDS but not recognized in the books shall be allowed as bad debt in the tax year in which it becomes irrecoverable and it shall be deemed as if such debt has been written off as irrecoverable in the accounts for this purpose.

8. Mandatory filing of tax return by resident in respect of foreign asset holding ►

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Under the ITL, a taxpayer who is resident and ordinarily resident is required to furnish return of income (ROI) mandatorily even if his total income does not exceed the maximum amount not chargeable to tax if, at any time during the relevant tax year, he had any asset including financial interest in any entity located outside India (Foreign asset) or he had signing authority in any account located outside India. The prescribed return form, together with instructions thereto, provides broad guidelines on categories of resident persons who are obliged to comply. The amendment explicitly specifies the coverage of person by mandating the furnishing of ROI by every resident taxpayer who, at any time during the tax year (a) holds, as a beneficial owner or otherwise, any asset (including any financial interest in any entity) located outside India or has signing authority in any account located outside India or (b) is a beneficiary of any asset (including any financial interest in any entity) located outside India. The provisions of amendment align with provisions relating to penalty and prosecution in the Undisclosed Foreign

9. Personal taxation related amendments 9.1 New Pension Scheme The FB 2015 proposed to enhance limits for annual deduction, in respect of investments made by individual taxpayers in New Pension Scheme (NPS) from existing limit of INR1 lakh to INR 2 lakhs. There persisted a doubt whether the proposed benefit can operate only if taxpayers made full investment of INR. 2 lakhs in NPS. The amended Bill makes it clear that if taxpayer makes investment of, say - INR 50,000 in NPS and say, INR1.50 lakhs in investments qualifying under other provisions, he can still avail the benefit of enhanced limit of INR 2 lakhs.

9.2 Medical insurance/expense deduction The Budget announcement proposed to enhance limits for deduction for payment of premium on medical insurance for self and family members from existing limits of INR15,000/INR 20,000 to INR 25,000/INR30,000. The text of FB 2015, however, did not contain specific amendment to increase the limit from

INR15,000 to INR 25,000. The amended Bill removes this anamoly and introduces amendment consistent with Budget announcement.

Comments Some of the amendments made in FB 2015 will be welcomed by taxpayers since they are made pursuant to representations made by the stakeholders post presentation of FB 2015 on 28 February 2015. Amendment to definition of POEM is a high relief. However, some amendments to provisions dealing with MAT on foreign companies, alignment with ICDS etc. may raise fresh concerns for taxpayers with potential for litigation. The concerns of stakeholders on interpretation of provisions dealing with indirect transfer remain unaddressed. As a process, the amended Bill will be transmitted to Rajya Sabha (upper house of the Parliament) for their suggestions and then to the President of India for his assent, before it is enacted as law.

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