The Finance Minister (FM), Mr Arun Jaitley, presented the highly anticipated Union Budget for 2015–16 on 28 February 2015, in what he described as a far more positive economic environment with India’s economy poised to take off on an improved growth trajectory.
The proposals of the Finance Bill, 2015 (FB 2015) seek to propel the Indian growth story by transforming India into an attractive investment destination once again, promoting industry through job creation, providing impetus to accelerated fiscal consolidation and a stable and predictable tax policy.
In terms of the impact on the financial services (FS) sector, the Budget is high on policy announcements, which if implemented, would lead to structural changes in the FS sector. Key among those include the proposal to legislate the Indian Financial Code, a comprehensive Bankruptcy Code, set up of Public Debt Management Agency, inclusion of NBFCs within the SARFESI Act, regulations enabling the launch of International Financial Centres, combining FDI and FPI caps on foreign investment, permitting foreign investment in Alternate Investment Funds (AIFs).
We take a look at some of the key tax proposals of the FB 2015.
Deferral of the controversial General Anti-Avoidance Rules (GAAR): In line with industry expectations, the FM announced the deferral of the controversial GAAR to the financial year 2017–18. What came as a further big impetus to investor sentiment was the announcement to grandfather all investments made up to 31 March 2017. One expects that the government will utilize the two-year period to clarify the various aspects of the GAAR law, including the issue of SAAR overriding GAAR and the provision of examples on GAAR applicability in different situations.
Clarifications on “indirect transfer” provisions: The FB 2015 provides long-awaited clarifications to certain contentious aspects of the law pertaining to the taxation of indirect transfer of assets situated in India. The FB 2015 proposes to define what could constitute “substantial value” and provides for the proportionality of taxation in India. Certain forms of indirect transfers are proposed to be excluded from the purview of the indirect transfer tax. However, an onerous reporting obligation together with the penalty for failure has been cast on an Indian concern (whose interest is being indirectly transferred) to report the transaction. Certain issues relating to the taxation of investors in a multi-layer FPI structure continue to remain an area of concern.
Onshore fund management: In order to incentivize the growth of a robust domestic fund management industry in line with the regime prevalent in some of the International Financial Centres, the FB 2015 proposes that the management of an overseas fund by a fund manager in India would not create a business connection of the overseas fund in India, and that the overseas fund would not be regarded as a tax resident in India. Effectively, this proposal will make the taxation of income of the fund neutral to the place of location of the fund manager. However, the operative provisions are rather prescriptive in nature, laying out several conditions, both for the fund and for the fund manager to avail of the safe harbor. One hopes that the FM will take a pragmatic view and dilute these conditions before the enactment of the FB 2015, if India is to compete globally with established financial centres and realize the ‘make in India’ vision for financial services.
Interest earned by foreign bank parent from India branch: The taxability of interest received by the head office/overseas branches of a foreign bank from an Indian branch has been a subject matter of extensive litigation between the tax authorities and foreign banks over the period of time. The FB 2015 as a rationalization measure proposes to amend the law to tax interest paid by Indian bank branches to its foreign head office/ branch by deeming the Indian bank branch and its head office to be distinct persons. Non-withholding of taxes on payment of interest would result in the dis allowance of interest expenditure at the hands of the Indian bank branch and attract a levy of interest and penalty.
Exclusion from Minimum Alternate Tax (MAT) provisions: The FB 2015 proposes to amend the MAT provisions so that the capital gains of an FPI shall be excluded from the purview of MAT. The amendment does not categorically propose to exclude the applicability of MAT provisions to FPIs. The fine print of this provision raises concerns for FPIs and other foreign investors on issues such as:
- Trigger of higher MAT taxation on interest income otherwise taxable at the concessional rate of 5%
- MAT applicability to FPI’s income in the past few years
- MAT applicability to PE investors and foreign companies having no presence in India
- Risk of levy of MAT even in cases where tax treaties provide a more favourable taxation (short term gains on government securities and corporate bonds)
Extension of time period for concessional rate of tax: As a measure to promote the investment climate, the 5% concessional tax rate for interest earned by the FPIs on government securities and specified bonds has been extended up to 30 June 2017.
AIF tax pass through: With the AIF regime reporting a steep growth since its introduction by SEBI in 2012, the FB 2015 proposes to rationalize the taxation regime for AIFs from the financial year 2015–16 by providing a pass through status to Categories I and II AIFs. This is again a welcome move by the Government and is in line with the international practice for taxation of collective investment vehicles. There are however some areas of concern arising from the details of the provisions, which include:
- No tax ”pass through” has been accorded to the income of the AIF which is in the nature of profits and gains of business or profession, i.e., such income is taxable at the AIF level. Without appropriate clarity in the tax law on the nature of gains realized by an AIF from its investment activities, this may result in tax authorities characterizing the gains from investments by AIFs as ”business profits” and thereby, taxing the AIF’s income at the fund level.
- AIF is required to deduct tax at 10% on the income (other than income taxable at the AIF level) payable to investors. This will result in a cash trap for various types of investors in the AIF, for instance low effective tax rate companies such as insurance companies, loss-making companies, exempt institutions, foreign investors in favorable tax treaty jurisdictions (say Mauritius/ Singapore).
- The net loss incurred by the AIF cannot be passed onto investors, i.e., loss can be carried forward and set-off only at the AIF level. This may result in additional tax outflow for investors who could have used the losses to set off against their taxable income. For an AIF which incurs terminal losses, the losses would be trapped for perpetuity.
The tax proposals announced by the FM outline the Government’s endeavor to foster a stable and predictable taxation policy. The Government has demonstrated the courage to deal with some of the long standing demands of the FS industry on taxation. While the fine print in some cases is a cause for concern, one cannot but help appreciate the efforts of the FM in dealing with the issues and hopes that even these creases will be ironed out before the proposals in the Bill are enacted by the Parliament.