Union Budget 2021
With the COVID-19 pandemic gripping almost the entire world, nations have seen unprecedented uncertainties. India has had its own challenges with respect to ramping up healthcare infrastructure, measures to revive the economy, and tapping investment opportunities in India, etc. With this backdrop, the Finance Minister of India presented the budgetary proposals which revolve around following six pillars –
a) Health and Wellbeing
b) Physical and Financial Capital, and Infrastructure
c) Inclusive development
d) Human Capital
e) Innovation and R&D, and
f) Minimum government and maximum governance,
The Budget laid a significant emphasis on capital investment/infrastructure development, with a proposed outlay of USD 75 billion earmarked for capital expenditure.
It has been heartening that neither any additional tax was introduced, nor any of the rates of direct taxes increased to meet government spending. We summarise some of the key direct tax proposals of international interest below:
Last year, the Finance Act 2020 broadened the scope of the Equalisation Levy (EL) by brining non-resident operators’ revenue from e-commerce supplies or services within its ambit. This action raised the following concerns:
- Overlapping of certain items of income i.e., subjected to tax both under the direct tax law (as royalties/fees for technical services) and under the EL.
- While widened scope of the EL was made effective from 1 April 2020, the exemption of such income under the direct tax law was made effective only from 1 April 2021. Thus, it resulted into potential double taxation in India.
With a view to addressing these issues, the Indian Budget has proposed the following clarifications:
- Transactions which are taxable as Royalties or Fees for Technical Services will be outside the scope of the EL.
- With effect from 1 April 2020, income subjected to EL will be exempt from tax under the Indian direct tax laws.
These proposals will ensure that taxpayers are not doubly taxed – both under the direct tax provisions and EL provisions.
Further, the Indian Budget includes a proposal to insert the definition of online sales of goods and online provision of services to cover the following activities taking place online:
(a) acceptance of an offer for sale;
(b) placing of a purchase order;
(c) acceptance of a purchase order; or
(d) payment of consideration.
Thus, the above proposed definition is wide enough to include several categories of e-commerce business models, as even if one of the above activities are being carried out online, that will constitute as online sale of goods or provision of services. Accordingly, businesses need to be mindful of the implications of the above EL proposals.
International Financial Services Centre (IFSC)
Over the past few years, the Government has been introducing several measures to support the development of a world class Fin-Tech hub – IFSC in GIFT City of Gujarat. With a view to attracting investment in IFSCs, the Indian Budget proposes granting the following further benefits:
- Relocation of funds: Capital gains arising from a transfer of investments by an original fund to a relocated fund setup in IFSC (i.e. a resultant fund) to be exempt from tax, subject to prescribed conditions. Furthermore, capital gains on a transfer of shares of an Indian company by a resultant fund in IFSC to be exempt from tax, subject to the fulfilment of specified conditions.
- Fund management: Subject to fulfilment of prescribed conditions, foreign investment funds with a fund manager in India, will not be regarded as having a permanent establishment in India. However, some of these conditions are onerous for foreign investment funds to comply with. The Indian Budget proposes that if the fund manager is located in an IFSC, some of these prescribed conditions will be relaxed.
- Aircraft leasing activities: Royalties paid by an eligible unit in IFSC to a non-resident for leasing an aircraft, are proposed to be exempt from taxes in India. Furthermore, any income arising from the transfer of an aircraft or an aircraft engine by an eligible unit in IFSC to a domestic company will be eligible for a 100% tax holiday.
- Banking units: Capital gains arising from a transfer of prescribed capital assets arising to the investment division of an offshore banking unit located in IFSC that has been granted a Category III Alternative Investment Fund registration will be exempt from tax. Similarly, income arising to a non-resident from a transfer of non-deliverable forward contracts to an offshore banking unit in IFSC will be exempt from tax in India.
Minimum Alternative Tax on dividend income
Finance Act 2020 abolished dividend distribution tax, and thereby dividend income was liable to tax in the hands of shareholders (including foreign investors). However, it was not previously proposed to introduce a provision clarifying that the provisions of the minimum alternative tax would not apply to foreign investors receiving dividend income from Indian companies. Now, the Indian Budget has proposed to clarify that the minimum alternative tax will not apply to foreign investors receiving dividend income from Indian companies.
Tax Withholding on dividend income
Under the existing domestic tax law provisions, payments of dividends to Foreign Institutional Investors (FII) are liable for tax withholding at a base rate of 20%. Whereas in case of the other foreign shareholders, payments of dividends are subject to tax withholding at a base rate of 10%, or at the rate prescribed under the applicable tax treaty with India, whichever is more beneficial. This had resulted in a mismatch between the withholding tax rate and the eventual tax liability on dividend income of such FIIs in India. To address this anomaly, the Indian Budget has proposed that the tax withholding on dividend income of FIIs can be carried out at the applicable and beneficial tax treaty rates, subject to fulfilment of certain conditions. The Indian Budget also proposes that dividend payments to REITs/InVTs will not be subject to withholding tax.
Business Structuring and Goodwill
In 2013, the Apex Court of India addressed the issue revolving around depreciation on goodwill arising on account of business structuring (i.e., amalgamations, demergers etc) or outright purchase of business, holding that such goodwill is an eligible asset for tax depreciation. The Indian Budget has proposed that any form of goodwill - whether purchased or generated as a result of business re-organisation - would not be eligible for tax depreciation. While the tax depreciation claim is proposed not to be available, taxpayers will be entitled to claim deduction of any costs incurred towards acquisition of such goodwill for the purpose of computing capital gains on the sale of such goodwill or business. This proposed amendment has raised various challenges for taxpayers who have been claiming tax depreciation on goodwill acquired in the past.
Restructuring of Authority for Advance Rulings (‘AAR’)
Under the existing provisions of domestic tax law, taxpayers (being non-residents and specified residents) can approach the Authority for Advance Rulings (AAR) to obtain tax certainty on transactions or arrangements they enter or propose entering into. However, the functioning of the AAR has been impacted in the past few years. Accordingly, with an intent to strengthen and streamline the tax certainty mechanism, the Indian Budget has proposed replacing the existing AAR with a Board for Advance Rulings (BARs), from a specified date. Therefore, specified pending matters before the AAR will be transferred to the BARs from a specified date.
For further details, see our Budget Booklet containing a detailed analysis of various amendments proposed by the Indian Budget.
The above article is based on the Finance Bill, 2021 as presented before the Lower House of Parliament on 1 February 2021.