The commencement of the new Financial Year beginning April 1, 2017, brings a paradigm shift in the fiscal and tax landscape in India. Implementation of the provisions of General Anti Avoidance Rules ('GAAR'), amendments made to the Double Taxation Avoidance Treaty between India-Mauritius, Singapore and Cyprus; introduction of thin capitalization rules, provisions of secondary adjustments marks a beginning of the second-generation reforms in the Indian Income Tax landscape.
General Anti Avoidance Regulations (GAAR)
The aim of GAAR is to consider the real intention of the parties, the effect of transactions and purpose of arrangement, for determining tax consequences, irrespective of legal structure which have been created to disguise the real intent and purpose. It empowers the tax authorities to deny the tax benefit, in situations where it can be proved that the transactions or arrangements do not have any commercial substance, business necessity or consideration other than achieving the tax benefit.
In any contemporary business environment, the presence of business reasoning and commercial rationale will be central to any structuring or investment arrangement, both inbound or outbound structuring.
Amendment made to Double Taxation Avoidance Treaties Significant Jurisdictions: Mauritius, Singapore & Cyprus
With the amendments to the Double Avoidance Taxation Agreement with Mauritius; Singapore and Cyprus, India would now have the taxing rights on the capital gains on sale of shares of an Indian Company held by a resident of any of the other countries. Such right shall be on capital gains arising on alienation of shares/ investments made in Indian company post April 1, 2017.
The amendment also provides for a two-year transition period wherein a reduced rate (50 percent of the tax rate of India) shall be levied on the capital gains arising on sale of shares of an Indian company, investments in which was made on or after April 1, 2017 but transferred during the period April 1, 2017 to March 31, 2019. However, the phase-in of such lower rate of tax is subject to the fulfilment of the conditions of main purpose test or bona-fide business test.
Thin Capitalization Norms
Thin Capitalization Regulations have now been introduced in the Indian Income Tax Act, 1961 ('Act'). The norms do provide for a restriction on the admissibility of the expense of interest paid to the associated enterprises. The interest expenditure incurred by Indian Company or a Permanent Establishment of a Foreign Company, pertaining to any debt received from an associated enterprise directly or indirectly, would be admissible upto 30% (Thirty Percent) of its earnings before interest, taxes, depreciation and amortization ('EBIDTA') or interest paid or payable to associated enterprise, whichever is less.
In case the interest expenses claimed are higher than 30% of EBIDTA, a carry forward of the disallowed (excess) interest expenditure shall be allowed for future eight years immediately succeeding the year in which the disallowance was first made. The carried forward interest expense shall be eligible for deduction as expenditure from profits and gains from business and profession, subject to the cap of interest expense being 30% of EBIDTA.
Transfer Pricing: Secondary Adjustments
The concept of secondary adjustments in Transfer pricing regulations has now been introduced. The newly incorporated provision provides for realigning the books of accounts of the tax payer and the associated enterprise in accordance with the arms-length price determined.
The difference between the transaction price and the arms-length price should be recognized in the books of accounts and the excess money receivable from the associated enterprise because such adjustment, if is not repatriated to India within the time as may be specified, shall be treated as an advance made to the associated enterprise and interest on such advance shall be computed and recognized as income in the hands of the taxpayer in India.
Exemption of Long Term Capital Gains on transfer of listed shares
From Year beginning April 1, 2017, exemption for income arising on transfer of equity share, being a long-term capital asset, listed on a recognized stock exchange, acquired on or after October 1, 2004 shall be available only if the acquisition of share was chargeable to Securities Transaction Tax ('STT') and the transfer is also chargeable to STT. However, tax department has proposed to carve out genuine situations such as Initial Public Offer, Bonus Issue, Right Issue, where STT is not being paid at the time of acquisition.
Bilateral Investment Treaties
On March 31, 2017, Bilateral Investment Treaty ('BIT') of India with several countries unilaterally terminated, since terms of the Bilateral Investment Promotion and Protection Agreements ('BIPAs') were not re-negotiated based on new model BIT. India brought out a new model BIT in December 2015, intending to replace its existing BIPA, after being dragged into international arbitration by foreign investors who sued for discrimination citing commitments made by India to other countries in bilateral treaties.
The terminated BITs will continue to be relevant for existing foreign investment in India and Indian investment in these countries for the next 10-15 years due to survival clauses.
Considering the recent situations, where India had to participate in the international arbitration, initiated by many multinationals on tax matters, the new model specifically excludes taxation matters in the new model treaty.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
