The year 2016 witnessed a rapid movement of the OECD-G20 BEPS project to the implementation phase, leaving a fundamentally changed landscape in its wake. Now that all the key instruments for BEPS implementation have been released by the OECD, countries are legislating and/or providing more clarity on how they will implement BEPS measures so that businesses have sufficient information to take stock and set a course to move forward. Across the globe, new and sometimes highly novel national legislation was released to address the BEPS challenges. The impact of the BEPS recommendations was seen in the 2016 Indian Union Budget with the introduction of equalization Levy on digital transactions, country-by-country reporting requirements and a patent box regime based on the nexus approach. India also completed the much-anticipated renegotiation of its tax treaties with Mauritius, Singapore and Cyprus, providing for source country taxation of capital gains, with grandfathering for existing investments. However, there is still some unfinished agenda arising from the recent legislative changes that the Finance Minister should address when he presents the 2017 Union Budget.
In the 2015 Union Budget, the Finance Minister had announced a phased reduction in Indian’s corporate tax rate from 30% to 25%. The business community eagerly awaits the roadmap for a rate reduction plan. A reduction in the corporate tax rate would be a catalyst in improving the competitiveness of the Indian economy.
In 2015, the tax law was amended to provide that from financial year 2015—16 onward, a foreign company would be treated as a resident of India if its place of effective management (POEM) is in India. The applicability of the POEM test to determine corporate residency was deferred by a year to 2016—17 in the 2016 Union Budget. However, the Government is yet to finalize the draft guidance on the determination of POEM. The test of POEM is one of “substance over form” and is to be determined with regard to the facts and circumstances of each case on a yearly basis. In the modern environment, however, the application of the traditional POEM factors may not result in a clear determination of POEM or may result in an outcome that does not appear to be in accordance with the policy intentions. Given these challenges, the Government may consider abandoning the POEM concept and reverting to the earlier test for control and management, which provided much greater certainty and clarity. The intention of POEM perhaps was to ensure that offshore companies with no substance or activities, which are controlled from India, are subject to the Indian tax jurisdiction. This policy intention can still be achieved by applying GAAR provisions, where appropriate, in abusive situations.
The 2016 Union Budget introduced Section 115BBF in the tax law under which income earned by an Indian resident developer of a patent would qualify for a preferential tax rate of 10%. With this, India joined the group of many countries that have enacted the so-called “patent or innovation box” regime in order to spur innovation. The regime typically grants a lower tax rate on profits from intangible property (IP), “boxing” them off from the rest of the system. The regime, however, currently applies to only income from patents registered under the Patents Act, 1970. The Government may consider extending the scope of the regime to IP assets that are functionally equivalent to patents such as formulas, processes, designs, patterns, know-how and inventions even though they may not be eligible for or may not have sought patent protection. Copyrighted computer software may also need to be included in the category of qualifying IP assets. Even though computer software may not be eligible for patent protection, it arises from the type of innovation and R&D that IP regimes are typically designed to encourage. This will ensure that a wider range of innovative and knowledge-based enterprises are eligible to claim the benefits. IP income that qualifies for the preferential tax treatment under Section 115BBF is consideration earned from exploiting the patent by transfer of use or other similar rights, including from rendering of services in connection with such exploitation. Income from the sale of goods manufactured or services provided using the IP is not a qualifying income. It may be noted that IP income may also be embedded in the sale of products, and benefits may need to be granted to such income as well. A consistent and coherent method — based on transfer pricing principles — may be applied for separating income unrelated to IP (e.g., marketing and manufacturing returns) from the income arising from IP.
Transfer pricing provisions were introduced in the tax law in 2001 to prevent the erosion of tax base of the country. There are many cases where Indian taxpayers may receive loans, services or licenses of intangibles from their overseas associated enterprises (AEs) with respect to which the overseas AEs may charge a consideration that may be less than arm’s length price. Now, any receipt of interest, fees or royalty on such loans, services or licenses, respectively, would attract income tax in the hands of the overseas AEs in India at 10% under the Act and/or tax treaties, where the overseas AEs do not have permanent establishments in India. On the other hand, payments of such considerations would result in tax deduction in the hands of the Indian taxpayer at 30%. Thus, the Indian taxpayers, by not paying consideration less than the arm’s length price, would have only benefitted in the form of tax savings at 20% thereof. However, a recent decision by the Special Bench of the Income-tax Appellate Tribunal in the case of Instrumentarium Corporation [TS-467-ITAT-2016] may result in a TP adjustment in the hands of the overseas AEs. In order to prevent the unintended application of the TP provisions in this manner, the Government could consider introducing a legislative amendment to clarify that the no upward TP adjustment may be made in the hands of foreign companies in India in such situations.
The international tax changes that may be implemented in the Union Budget 2017 could be far-reaching. International investors would need to carefully monitor the developments and assess their impact on their operations.
(The views expressed here are personal)
(Rajendra Nayak, Partner, International Tax Services, EY India)