Introduction
India’s Union Budget (the “Budget”) was announced on February 29, 2016, and the Finance Bill, 2016 (the “Finance Bill”) was tabled in Parliament. Most of the income tax proposals in the Finance Bill will be effective from the financial year commencing on April 1, 2016, unless specified otherwise. The Finance Bill will be discussed in Parliament before its enactment, and therefore, it is likely that the Finance Bill may be amended as a result of these discussions. Find the Finance Act, 2016 here.
According to the Finance Minister, India has registered robust and steady economic growth in the current financial year (April 2015 to March 2016) despite a turbulent external environment. India’s Gross Domestic Product (GDP) is estimated to be 7.6% compared with 7.2% in the last financial year. When compared to the average global growth of 3.1% in 2015 estimated by the International Monetary Fund and the fact that emerging economies are consistently experiencing a declining growth rate since 2010, India’s growth rate of 7.6% appears promising.
We have summarized below some of the key regulatory and income tax proposals.
Proposed Changes to the Foreign Direct Investment (“FDI”) Policy
- Insurance/Pension Sectors: Foreign investment will be allowed in the insurance and pension sectors under the automatic route up to 49%, subject to the guidelines relating to control of the joint venture company, which has to be with the Indian partner. Currently, for FDI above 26%, government approval is needed.
- Asset Reconstruction Companies: FDI in Asset Reconstruction Companies (“ARCs”) will be permitted up to 100% under the automatic route.
- Foreign Portfolio Investors (“FPIs”): FPIs will be allowed up to 100% in each tranche of securities receipts issued by ARCs, subject to sectoral caps. The existing 24% limit for investment by FPIs in central public sector enterprises, other than banks, listed on stock exchanges, will be increased to 49% to obviate the need for prior government approval to increase the FPI investment.
- Indian Stock Exchanges: The FDI limit for foreign entities in Indian stock exchanges will be enhanced from 5% to 15% bringing it on par with domestic institutions.
- Non-banking Financial Sector: FDI will be allowed beyond the eighteen (18) specified non-banking financial activities under the automatic route in activities which are regulated by financial sector regulators.
- Residential Status under “Make in India”: With a view to promote the “Make in India” initiative, foreign investors will be accorded residential status subject to certain conditions.
Proposed Changes to Tax Laws
- Place of Effective Management: The implementation of the rules determining the residential status of a foreign company on the basis of its place of effective management have been deferred by one year and will apply with effect from April 1, 2017.
- Minimum Alternate Tax (“MAT”) on Foreign Companies: Taking into account the recommendations of the A.P. Shah Committee, MAT will not be levied on foreign companies (including FPIs) retrospectively with effect from April 1, 2001, if the foreign company or FPI does not have a permanent establishment (“PE”) or a business connection in India. This change will bring cheer to FPIs on whom the income tax authorities had issued notices last year seeking to tax their capital gains.
- International Financial Centre (“IFC”): With a view to facilitating the setting up of IFCs in India, certain tax benefits have been provided to companies located in IFCs. Some of them are: (a) companies located in IFCs will not be liable to pay dividend distribution tax (“DDT”); (b) MAT will be charged at the rate of 9%; (c) a sale of equity shares of companies in IFCs on a recognized stock exchange will not be liable to securities transaction tax; (d) the gains arising from the transfer of shares or units of companies in IFCs will be exempt from long term capital gains tax; (e) any transaction in foreign currency of sale of commodity derivatives taking place on a recognized association in an IFC will not be liable to commodity transaction tax.
- Withholding Tax on Payment to a Non-resident: The withholding tax provisions will be amended, and the higher rate of withholding tax in case of a payment to a non-resident not having a permanent account number will not apply, subject to prescribed conditions.
- Securitization Trusts: A complete tax pass through status will be given to securitization trusts.
- Certain Activities of a Non-resident not to be Construed as a Taxable Business in India: (a) In the case of a foreign company, mere storage of crude oil in India will not constitute a business connection, and the income arising or accruing on storage and sale of the crude oil, subject to fulfilment of certain conditions, will not be liable to tax in India. (b) In the case of a foreign company engaged in the business of mining diamonds, no income shall be deemed to accrue or arise in India to it through or from the activities which are confined to the display of uncut and unassorted diamonds in a notified special zone.
- Transfer Pricing: The country-by-country reporting and master file submission requirements will have to be followed by every member or partner country. Otherwise, there will be penal consequences.
- Digital Economy: With the expansion of information and communication technology, the supply and procurement of goods and services digitally have undergone an exponential expansion in India. These new business models have created new tax challenges, namely, the difficulty in characterizing the nature of payment and establishing a nexus or link between a taxable transaction, activity and a taxing jurisdiction; and the difficulty of locating the transaction, activity and identifying the taxpayer for income tax purposes. Thus, a new chapter titled “Equalization Levy” will be introduced in the tax statute to provide for an equalization levy of 6% on the total consideration received or receivable by a non-resident not having a PE in India for providing online advertising, digital advertising or any other facility or service for online advertisements as may be specified by the Central Government. These provisions appear to emanate from the BEPS recommendations on the subject and may impact global majors like Google, Yahoo and the like who derive substantial online advertisement revenue from Indian customers or otherwise through their Indian subsidiaries. Find our update on Equalization Levy Rules, 2016 here and our recent case update on equalisation levy here.
- Start-ups: With a view to providing an impetus to start-ups and facilitating their growth in the initial phase of their business, it has been proposed to provide a deduction of 100% of the profits and gains derived by an eligible start-up from a business involving innovation development, or deployment or commercialization of new products, processes or services driven by technology or intellectual property. The benefit will be available to an eligible start-up which is established before April 1, 2019.
- Dividend Taxation for Residents: Under the existing provisions of the tax statute, dividends which suffer DDT are exempt in the hands of the shareholder. It has now been proposed that any income by way of dividend in excess of Rs.1,000,000 (approx. US$14,705) will be chargeable to tax in the case of an individual, Hindu Undivided Family (HUF) or a firm who is a resident of India, at the rate of 10% of the gross payment.
- Krishi Kalyan Cess: An additional tax at the rate of 0.5% will apply on all taxable services with effect from June 1, 2016. The proceeds will exclusively be used for financing initiatives for the improvement of agriculture and the welfare of farmers.
Overall, the Budget seems to be positive. It gives an impetus to rural growth while trying to keep the fiscal deficit at reasonable levels. Additional tax burdens have been imposed on rich Indian residents through the dividend tax and increased excise duties on manufactured goods like automobiles, tobacco, etc. We are going through the fine print of the Finance Bill and will be circulating a more detailed update in the next few days.