The revised proposals, however, seek to fulfill the promise and address the areas of concern identified in the first round of consultation in some measure. There is some relief for the India INC in general and non-residents in particular.
Minimum alternate tax (MAT) is principally a liability fastened on all the corporate tax payers to pay tax of at least 18% on their adjusted book profits determined from the corporate set of financial statements. MAT applies where tax payable by regular application of tax laws is less than 18% of its book profits. DTC proposed a MAT based on a tax on gross assets, providing a much larger tax base and a huge deterrent for projects with large investments in assets and a long gestation period.
While there may not be much income in the initial years, the original proposals would have compelled such project companies as also other players with heavy investments in assets to pay tax on the value of their gross assets in the absence of profits. Thankfully, the revised proposals promise to revert back to the extant method of computation of MAT based on book profits. While there is not much information on the rate of tax at this stage, a genuine relief craves for reduction from the present level of 18%.
Special Economic Zones (SEZs) and the direct and indirect tax benefits accorded to the developers as well as individual SEZ units have always evoked strong debate. Finance ministry clearly does not think too highly of profit linked deduction that largely seeks to exempt the profits of an eligible enterprise from payment of tax for a definite period. Investment linked deductions are the current flavour in view of the underlying belief that when you provide exemption from payment of tax based on investment and development outlays you support capital formation in the economy creating larger overall economic opportunities.
However, equally important is the need to protect the existing players who made commitments relying on the extant policy regime. Thus, revised proposals accord tax holiday protection enjoyed by the business units currently operating out of SEZs for the unexpired period. The SEZs developers were already protected by the original proposals.
The non-resident tax package is certainly more benign then the original proposals in the DTC and provides a sigh of partial relief to the non-resident players.
To begin with, the test of tax residence for a foreign company is proposed to be determined by application of the test of ‘place of effective management’. In other words, a foreign company will now be exposed to a tax residence in India if it has a place of effective management in India. Place of effective management is where the board of directors/executive directors tasked with management responsibilities make their decisions.
The new test is clearly an improvement over the original proposal where a foreign company will have been exposed to Indian tax residence even if a part of control and management of its affairs situated in India for any part of the year. Presently, a foreign company becomes a tax resident in India only where the control and management of its affairs is wholly situated in India. The implication of a tax residence in India is a tax liability at 36.25% subject to exposure of a permanent establishment as well where a tax treaty is applicable.
Controlled foreign corporations rules (CFCs) i.e. set of rules which deal with tax liability in respect of income from a foreign company controlled by a resident taxpayer will be introduced in the DTC. The immediate casualty is tax liability in respect of passive income such as dividends from overseas company becoming taxable in India even if the income is not actually received. A deeming fiction will take care of the attribution of income in the hands of the parent resident in India. The objective is to counter the deferral of tax payments by omission of actual distribution of income.
Our overseas direct investment activities despite some headline acquisitions are still at an early stage of evolution and may not be able to sustain without support from regulatory and tax policymakers. The introduction of CFC rules could be a little pre-mature in view of the incubation phase it is in.
Even if the CFC regime is to be introduced immediately, checks and balances which are an important aspect of any balances fiscal regime will need to be put in place. The mechanism of underlying tax credits for income already taxed in the home jurisdiction of the overseas group company/subsidiary should be strengthened. This may be done keeping in view the constraints and possibilities offered by the tax treaties that India has already concluded with major industrialized countries.
Another absorbing area in the originals proposals is the issue of applicability of the provisions of domestic tax laws or the provisions of applicable tax treaty to an eligible taxpayer. The answer lies in applying the time tested principle of treaty overrides meaning that the provisions of the tax treaty will apply if the same are more favorable to the taxpayer than the domestic tax laws. However, the original proposals put on blocks the principle of treaty override and the letter and spirit of Vienna convention.
This was done by prescribing a later-in-time rule for assessing whether the principle of an applicable tax treaty or the domestic law will apply in relation to an eligible taxpayer. Obviously, the new tax laws and its provisions will have been later-in-time than the tax treaties already concluded and will have applied leading to chaotic and litigious tax assessments.
As a major relief, the treaty overrides principle has been restored. However, in an interesting spin, it has been provided that the provisions of applicable tax treaty will not have preferential status where CFC rules or general anti-avoidance rules (GAAR) are invoked or where the branch profits tax at 15% on the income after corporate tax of a foreign company are to be levied.
The limited exceptions to the larger principle of treaty override have been projected as an acceptable adjustment in terms of international principles. It will be interesting to see as to how the carve-outs interface with the Vienna convention on international treaties between two countries. The overall tone, theme and spirit behind the tax treaties India has concluded will also be another important factor.
Introduction of GAAR in the DTC led to widespread fears rooted in anticipation of arbitrary and subjective application. GAAR seeks to identify an impermissible avoidance agreement and overlook steps or part of a transaction or arrangement between two parties to analyse the real motive and assess tax accordingly. The revised proposals seek to soften the blow. The tax department will now clarify the circumstances under which the GAAR may be invoked and also the threshold limits of tax avoidance beyond which GAAR will apply. In addition, the taxpayer will be permitted to make a case against application of GAAR at the newly constituted Dispute Resolution Panel.
DTC originally provided for a lower threshold for determining related party relationship in relation to transfer pricing regulations i.e. 10% voting power instead of 26%. This may result in related party relationships even where any critical participation in capital, control or management is absent. Sadly there is no relief on that account at least in the revised proposals. Similarly, more clarity was expected in relation to advance pricing agreements that the tax department will enter with the taxpayer for a front-end determination of arms length prices in international transactions.
The tax rates, tax slabs and various thresholds under the new regime are a sort of package deal from the perspective of ex-chequer. However, the entire tax rate card is conspicuously absent from the scene and will invite attention and comments possibly upon introduction of the Bill in the ensuing monsoon session of Indian Parliament. Recent reporting in the print media suggests that there could be good news on the rates front also despite the roll-backs and reliefs.
Pursuant to a consultation window that expires on June 30, 2010, a final shape will be given to the Bill and the same will be introduced in the Parliament. The Bill is expected to be reviewed by the concerned standing committee of the Parliament as part of the legislative process providing another opportunity for comments.
There is a general expectation that the new law become effective in respect of income earned on and from April 1, 2011. To achieve this, the standing committee phase will require deft floor management and persuasion skills from the present dispensation at the Centre. Incidentally, it has the requisite skill sets and the experience with the Finance Minister Pranab Mukherjee acting as the driving force and catalyst for the much awaited change.
Hopefully, by next year, DTC and its indirect tax twin GST will be a harbinger of much needed simplicity and certainty in our tax laws.
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