Introduction
India’s Union Budget (the “Budget”) was announced today (February 1, 2021), and the Finance Bill, 2021 (the “Finance Bill”) was tabled in Parliament. The Finance Bill will be discussed in Parliament before its enactment, and therefore, it is likely that the Finance Bill may be amended because of these discussions. Once enacted, unless specified otherwise, most of the income tax proposals in the Finance Bill will be effective from the financial year commencing on April 1, 2021.
We have summarized below some of the key policy and income tax proposals made in the Budget that will impact M&A transactions, and private equity and sovereign fund clients.
No depreciation on goodwill
Under the Income-tax Act, 1961 (the “IT Act”), the definition of the term “block of assets” means a class of assets comprising, tangible assets, buildings, machinery, plant or furniture, and intangible assets like know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature in respect of which the same percentage of depreciation is prescribed. The goodwill of a business has not been specifically listed as an asset in the definition. However, in the Smiff Securities case, India’s Supreme Court ruled that goodwill is to be treated as a depreciable asset.
Under the Finance Bill, goodwill has now specifically not been allowed as a depreciable asset, and where goodwill is purchased by a taxpayer, the purchase price of the goodwill can only be considered as a cost of acquisition for computing capital gains. This is a significant change that has overruled the Supreme Court’s decision and will impact tax workings in M&A transactions for a buyer.
The amendment will take effect from April 1, 2021 and shall apply to assessment year 2021-22 and subsequent assessment years.
Slump sale includes a slump exchange attracting capital gains tax
A slump sale is defined to mean the transfer of one or more undertakings for a lump sum consideration but without values being assigned to individual assets and liabilities, and the IT Act contains a special provision for the computation of capital gains in case of a slump sale. The Finance Bill states that a sale transaction is often disguised as an ‘exchange’ by the parties to the transaction with a view to avoiding tax.
The Finance Bill proposed to amend the definition of the term “slump sale” to include all types of “transfer” as defined in section 2(47) of the IT Act, including an exchange. This is a significant proposal which overrules rulings of Tax Appellate Tribunals and High Courts where it has been held that a slump exchange is not a sale, and therefore, no capital gains tax can be attributed to such a transaction.
This amendment will be effective from April 1, 2021 and shall apply to assessment years 2021-22 and subsequent assessment years.
Income escaping assessment – time limit to reopen assessment reduced
Under the IT Act, in respect of incomes escaping tax assessments, among others, the tax officer has the power to reopen or recompute the income of a taxpayer for a given financial year within a period of four (4) years from the end of the relevant assessment year or within a period of six (6) years from the end of the relevant assessment year if the amount of income exceeds Rupees One Hundred Thousand (approx.US$1,370).
The Finance Bill proposes to reduce the time limit for issuance of notices to reopen the assessment to three (3) years from the end of the relevant assessment year and only in cases where the tax officer has in his possession evidence to show that income escaping assessment, represented in the form of assets, amounts to more than Indian Rupees Five Million or more (approx. US$68,493). Moreover, such a notice cannot be issued beyond the period of ten (10) years from the end of the relevant assessment year. The amendment will take effect from April 1, 2021.
This proposal is likely to provide significant relief to taxpayers.
Increase of the stamp duty safe harbour limit to 20% for land deals
Certain provisions of the IT Act inter alia provide that where the consideration declared to be received or accruing as a result of the transfer of land or building or both is less than the value adopted by a stamp valuation authority for the purpose of payment of stamp duty in respect of such transfer, the value so adopted shall be deemed to be the full value of consideration for the purpose of computing profits and gains from the transfer of such assets. The provision also states that if the stamp duty value that is adopted by the authority (for the purpose of payment of stamp duty) does not exceed 110% of the consideration, the consideration actually received shall be deemed to be the full value of the consideration. Thus, the current provision provides for a 10% safe harbour. The Finance Bill has proposed to increase this to 20%. This amendment will take effect from April 1, 2021. This is likely to boost the demand in the real estate sector and to enable real estate developers to liquidate their unsold inventory at a lower rate to home buyers.
Eligible start-ups
The existing provisions of the IT Act, inter alia, provide for a deduction of an amount equal to 100% of the profits derived from an eligible business by an eligible start-up for three (3) consecutive assessment years out of ten (10) years at the option of the taxpayer. This is subject to the condition that the eligible start-up is incorporated after April 1, 2016, but before April 1, 2021.
To help eligible start-ups and assist investments, the Finance Bill has proposed to extend the outer date of incorporation until March 31, 2022.
Please see our update on Union Budget 2022-2023 for the further extension provided to eligible start-ups on the outer date of incorporation.
Exemption of deduction of tax at source on payment of dividends to a business trust
The provisions of the IT Act provide for tax withholding at source at the rate of 10% on dividends dividend to an Indian resident. The Finance Bill has proposed that the tax withholding will not apply to dividend incomes that are paid to a business trust by a special purpose vehicle as may be notified.
This amendment will take effect retrospectively from April 1, 2020.
Tax incentives for units located in International Financial Services Centre (IFSC)
The Indian government has established a world-class financial services centre in Gandhinagar, Gujarat. Units that are located in the IFSC are eligible for tax concessions. To make the IFSC more attractive, the Finance Bill has proposed to provide the following incentives:
- The activities of a fund manager shall not constitute a “business connection” in India if an eligible investment fund or fund manager is set up in the IFSC and has commenced operations on or before March 31, 2024.
- A tax exemption will be available for income received by the investment division of an offshore banking unit (to the extent attributable and computed in a prescribed manner) that has commenced operations on or before March 31, 2024.
- A tax exemption will be provided to the income received by a non-resident as a result of a transfer of non-deliverable forward contracts entered into with an offshore banking unit of the IFSC that has commenced operations on or before March 31, 2024, and fulfils prescribed conditions.
- A tax exemption will be available to a non-resident in respect of royalty income on account of lease of an aircraft paid by a unit of the IFSC that has commenced operation on or before March 31, 2024.
- A tax exemption will be available on the capital gains income arising or received by a non-resident, which is on account of transfer of shares of a company resident in India by the resultant fund, and such shares were transferred from the original fund to the resultant fund in the case of a relocation. The Finance Bill has inter alia defined the terms: (i) Original Fund as a fund established outside India that collects funds from its members for investing for their benefit; and (ii) Resultant Fund as a fund established or incorporated in India in the form of a trust, company or limited liability partnership that has been granted a certificate of registration as a Category I, Category II or Category III Alternative Investment Fund and is regulated under the Securities and Exchange Board of India (Alternative Investment Fund) Regulations, 2012.
The Finance Bill proposals will encourage fresh foreign investments into the IFSC.
The amendments will be effective from April 1, 2022, and will apply to the assessment year 2022-23 and subsequent assessment years.
Please see our update on Union Budget 2022-2023 for recent tax exemptions announced on incomes received from International Financial Services Centre units.
Tax withholding on payments made to Foreign Institutional Investors (“FIIs”)
The provisions of the IT Act provide for tax withholding on the income of an FII from securities at the rate of 20%. In this regard, FIIs have had difficulties before the tax assessing officer to claim the beneficial rates of taxes as provided under a double taxation avoidance agreement (a “DTAA”).
The Finance Bill has proposed that taxes shall be deducted at the rate of 20% or at the rates of income tax provided in a DTAA for such income, whichever is lower. This amendment will be effective from April 1, 2021.
Sovereign Wealth Funds (SWF) and Pension Funds (PF)
The IT Act provides an exemption to certain specified persons from income in the nature of dividends, interest and long-term capital gains arising from an investment made by it in India. The specified persons are SWFs or PFs that fulfil conditions specified by the Central Government. The Finance Bill has proposed the followings amendments.
- Allowing Alternate Investment Fund (AIF) to invest up to 50% in non-eligible investments: Presently SWF/PFs can invest in a Category-I or Category-II AIF having 100% investment in an eligible infrastructure company. It has been proposed to relax the condition of 100% to 50% and allow investments by Category-I or Category-II AIFs in Infrastructure Investment Trusts.
- Investments through a holding company: Presently, SWFs/PFs are not allowed to invest through a holding company. The Finance Bill has proposed to allow this subject to the condition that the holding company (i) should be an Indian resident company; (ii) should be set up and registered on or after April 1, 2021; and (iii) should have a minimum 75% investment in one or more infrastructure companies.
- SWFs and PFs can invest in non-banking finance companies/infrastructure debt funds/infrastructure finance companies (NBFC-IDF/IFC) if the NBFC-IDF/IFC qualifies for a minimum 90% lending to one or more infrastructure entities.
- Presently, SWF/PFs are not allowed to undertake any commercial activity. The Finance Bill has proposed to remove this condition but with a caveat that SWFs/PFs should not participate in the day-to-day operation of the investee. However, appointing directors for monitoring the investment will not amount to participation in day-to-day operations.
The Finance Bill proposals will encourage fresh foreign investments from sovereign wealth funds and global pension funds into India.
The proposed amendment will be effective from April 1, 2021 and will apply to assessment year 2021-22 and subsequent assessment years.
These are some of the important changes that will impact M&A deals and fund clients. Our tax team is available to assist you or your clients on any clarifications or tax impact assessment.
About The Author
Ravi S. Raghavan has more than 25 years of experience in corporate tax advisory work, business re-organizations, international taxation (investment and fund structuring, repatriation strategies, treaty analysis, advance rulings, exchange control regulations, FPI taxation), tax litigation services, and other tax issues (including withholding taxes, capital gains tax, permanent establishment concerns, employee taxation, and tax holiday schemes).
Ravi has spoken at different forums on various tax matters, including at the Annual India Tax Forum in New Delhi, and at the Annual Symposium on India’s Taxation Regime at the National Law School of India University, Bangalore.