indian merchants chamber amendments proposed in finance bill 2013 panel discussion

INDIAN MERCHANTS CHAMBERAMENDMENTS PROPOSED IN FINANCE BILL 2013PANEL DISCUSSION

21 March 2013

Bela Sheth Mao

Country Tax Lead

Shell India Markets Pvt LTd

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CONTENTS

1. GDP and tax collections

2. Tax residency certificate (TRC)

3. Pass through status – Alternate Investment Fund (AIF)

4. Special Audit

5. Defective return

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GDP AND TAX COLLECTIONS

Economists caution that buoyancy in revenue collection will depend on maintaining the GDP growth rate in the range of 9 – 10%. The tax GDP ratio during fiscal 2010-11 was 10.8%.

Given the budgeted estimates of GDP, there will be pressure on the tax administration to meet revenue targets through aggressive assessments

Financial year GDP Direct tax collections

(INR lac crores)

Direct tax collections

(USD billion)

2009-10 8% 3.6 65

2010-11 8.6% 4.4 80

2011-12 (budgeted) 7.5% 5.1 92

2011-12 (registered)

5% 4.98 90

2012-13 (budgeted) 7% 5.7 103

2012-13 (revised) 5% 5.65 103

2013-14 (budgeted) 6.1 – 6.7% 6.7 122

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TAX RESIDENCY CERTIFICATE (TRC)

Scenario up to the Budget

Section 90(3) inserted in the Income Tax Act, 1961 (‘Act’) with effect from 1 April 2013 requiring non-residents claiming treaty relief to obtain a TRC in a prescribed format

Several judgments affirming Mauritius treaty benefits (in context of capital gains relief) based on TRC, following Azadi Bachao Andolan which affirmed Circular 789

The CBDT issued a Notification dated 17 September 2012 specifying the format of the TRC which required certain particulars on the non-resident to be verified by the overseas Government

Some jurisdictions are issuing TRCs in the required format (Singapore; Mauritius), some are flat refusing (USA; UK), some are issuing partial TRCs (Luxembourg)

There is no clarity on what happens when the TRC is not obtained in the required format

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Budget, 2013

In the Budget announced on 28 February 2013, a new Section 90(5) is proposed to be introduced in the Finance Bill, 2013

Its language seems to suggest that the TRC is essential but not sufficient to avail treaty benefits. Further, the amendment would be effective 1 April 2012

No indication on what happens if the TRC is not obtained in the specified format

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Post Budget clarifications

The TRC will be accepted as evidence of residency

The language of the proposed Section will be taken up for consideration in the Budget session of the Parliament

Circular 789 dated 13 April 2000 in reference to Mauritius remains in force

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Implications

Capital gains derived by Mauritius residents protected, in particular short term capital gains derived by FIIs

Circular 789 and Azadi Bachao Andolan still hold good in law

However, additional information may still be called for to satisfy the ‘beneficial ownership’ test to avail treaty benefits even if the new Section is not enacted

Scrutiny likely under anti-avoidance rules even if TRCs are obtained once GAAR takes effect in April 2016 (no amendments to GAAR provisions in the Budget – treaty override still exists)

TRC assumes importance because there is a significant impact when treaty benefits are not available

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Implications (contd.) Tax rate on royalty / FTS has been changed to 25% from

10% No change in the impact of Section 206AA of the Act Example - implications under the India – Singapore treaty

Situation where payee holds

Royalty

LTCG on unlisted shares

TRC and PAN 10% NIL

PAN but not TRC 10%1 20%3

TRC but not PAN 20%2 20%2

Situation where payee holds

Royalty

LTCG on unlisted shares

TRC and PAN 10% NIL

PAN but not TRC 25%1 20%3

TRC but not PAN 25%2 20%2

Pre - Budget

Post - Budget

1. Under Section 115A of the Act2. Under Section 206AA of the Act3. Under Section 112 of the Act4. The table does not factor surcharge and education cess

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Business impact

The logistics of obtaining TRCs• They are usually issued based on calendar year where

as assessments are done on a financial year – timing mismatch

• Payments to non-residents are recurring, real time and often there is not enough time to obtain a timely TRC – post payment event

If jurisdictions are not issuing TRCs as required by the Indian tax authorities, the WHT impact on royalty / FTS payments with changes in Section 115A will be significant

If it is a net of tax contract, the tax impact will be 33.33% - this is a significant cost of doing business in India

Most overseas group entities to whom payments are made are ‘pooling entities’ – it may be difficult to establish ‘beneficial ownership’

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PASS THRU STATUS – ALTERNATIVE INVESTMENT FUNDS

Scenario up to the Budget

On 21 May 2012 SEBI introduced guidelines for Alternative Investments Funds (AIFs) which are funds incorporated or established in India for the purpose of pooling of capital from Indian or foreign investors

These guidelines have replaced the SEBI Venture Capital Fund guidelines

AIFs regulated under these guidelines should not be covered under the SEBI Mutual Fund or Collective Investment Scheme regulations

AIFs can take the form of a trust or a company or a LLP and can operate broadly under 3 categories, and it is mandatory for them to get registered with SEBI

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Scenario up to the Budget (contd.)

Activities of AIFs

Under Section 10 (23F) of the Act, venture capital companies are exempt from tax on dividends and capital gains earned where certain specified conditions are met

Accordingly, they enjoy pass through status to the extent that tax is payable on distributions to investors

Category of AIF Activity

Category I Social Venture Fund, Infrastructure Fund, VC Fund, SME Fund

Category II PE Funds, Debt Funds, Funds of Funds

Category III Hedge Fund, Open-ended Funds, Funds trading for short term returns

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Budget, 2013

In the Budget announced on 28 February 2013, a new Section 10(23FD) is proposed to be introduced in the Finance Bill, 2013 where the venture capital exemption is proposed to be extended to Category I AIFs registered with SEBI

This applicable where:• The AIF is not listed• 2/3rds of its funds are invested in unlisted securities, and• Directors or related parties do not hold more than 10% equity in

in invested companies

‘Angel investor pools’ will also be covered by this exemption if they are recognised by the SEBI as Category I AIFs

Exemption not extended to Category II and III AIFs (possibly because of nature of activities)

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Implications

Qualifying income of Category I AIFs (including angel investor pools) will be exempt from tax

Depending on the nature of the fund vehicle, the distribution of income to members could be tax free, specially if the members are residents of Mauritius or Singapore which have favourable tax treaties with India

AIFs if set up as companies would not be subject to rigours of Section 56(2)(viib)

Most angel investors may not qualify for Category I AIF because the minimum contribution by members is Rs 1 crore, and most angel investors are individuals who often invest less than that

Angel investors provide small amounts of capital at the start-up stage while venture capitalists enter later in the cycle. By raising minimum investment threholds and offering preferential treatment to pools, the Budget may induce angels to behave like venture capitalists and reduce access to capital for very small start-ups

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SPECIAL AUDIT – SECTION 142(2A)

The Section provides that having regard to the ‘nature and complexity’ of the accounts of an assessee and the interests of the revenue, the Assessing Officer (AO) may with the permission of the Chief Commissioner or Commissioner, direct the assessee to have the accounts audited

The expression ‘nature and complexity’ of accounts and thereby the power of the AO to direct the audit has been the subject of different interpretation by various Courts

The Supreme Court in Sahara India (Firm) v. CIT 169 Taxman 328 held that• The word complexity is not defined in the Act• It is a nebulous word• It relied on its dictionary meaning• All that is difficult to understand cannot be regarded as

complex. Objectivity has to be applied.• There has to be a genuine and honest attempt by the AO to

understand the accounts and AO cannot use the provision to shift the responsibility to the auditor

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In Delhi Development Authority v. Union of India (25 Taxman 234) the Delhi High Court held that accounts do not become complex merely because there are a large number of entries.

In V. Vishnudas Kini v. DCIT (109 Taxman 15) the Kerala High Court justified the special audit as gross receipt were more than Rs 2 crores, volume of vouchers were large, and correctness of expenses could not be verified without significant effort.

In ATS Infrastructure Ltd v ACIT (30 Taxman 361) the Allahabad High Court confirmed the special audit as the assessee had opted for a dubious method of accounting.

In view of the divergent views, possibly to reduce litigation and bring clarity, the powers of the AO to direct the special audit have been widened.

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The AO can now order a special audit not only due to the reason of nature and complexity of accounts, but also in the following additional circumstances:• The Volume of accounts• Doubts over correctness of accounts• Multiplicity of transactions in the accounts• Specialised nature of business activity of the assessee

It is evident that some of the amendments have been inserted to counter some of the judgements that have been passed in favour of assessees

The amendments significantly broaden the power of the AO without defining the scope within which the powers can be exercised. This may not reduce the probable purpose of reducing litigation.

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A corresponding amendment is also proposed in Section 153 in respect of period of the special audit to be excluded from the period of limitation for completion of assessment and re-assessments

The amendment provides that the period to be excluded shall be:• The period commencing from the date on which the

AO directs the assessee to get his accounts audited under Section 142(2A); and

• ending with the last date on which the assessee is required to furnish a report of such an audit under that Section; or

• Where such direction is challenged before a Court, ending with the date on which the order setting aside such direction is received by the Commissioner

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DEFECTIVE RETURN – SECTION 139(9)

The Explanation to Section 139(9) provides nine conditions which are required to be fulfilled for an AO not to regard a return of income as defective

The Finance Bill, 2013 proposes to insert a new clause with effect from 1 June 2013 stating that the return will be regarded as defective if self assessment tax (along with interest) has not been paid on or before the due date of furnishing of the return

The memorandum explaining the proposed amendment states that this amendment has been proposed because it has been noticed that a large number of assessees are filing their income tax returns without payment of self assessment tax

The amendment seems to be aimed at individual assessees

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DEFECTIVE RETURN – SECTION 139(9)

In the context of non-resident corporate assessees, this situation is likely to arise when:• There may be uncertainty on the taxability on Indian

source of their income (usually whether activities constitute a PE or not)

• adequate WHT has not been withheld and deposited from Indian source taxable income, and the due date for last instalment of advance tax has passed

• the due date of filing the income tax return is near

indian merchants chamber amendments proposed in finance bill 2013 panel discussion

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