6 th Asia/Africa IFA Conference, 2012 (Mauritius) INDIA’s DIRECT TAXES CODE Report of Parliamentary Standing Committee 1 By:- SUNIL GUPTA Joint Secretary (Tax Policy and Legislation) Ministry of Finance New Delhi, India.

Direct Taxed Code (DTC): Present Status In Aug, 2010, DTC Bill, 2010 was introduced in the Lok Sabha. Referred to Parliamentary Standing Committee (PSC) on Finance The PSC invited comments from all stakeholders including public, trade and industry, professionals in India and abroad. Based on such inputs including response from Ministry of Finance and personal hearings, PSC has submited its report to Parliament. As per the recommendations of the PSC, amendments are to be carried out in the DTC Bill, Thereafter, the DTC Bill as amended will be taken for consideration by the Parliament so that new Code comes into force from 1 st April,

Direct Taxes Code – Key features General Anti-Avoidance Rule (GAAR) Controlled Foreign Company Rules (CFC) Advance Pricing Agreements (APA) Residence of Companies - “place of effective management” criterion Taxability of Indirect Transfers

DTC: General Anti-Avoidance Rule Impermissible Avoidance Arrangement – Where main purpose is to obtain tax benefit and – The arrangement Creates rights or obligations which would not normally be created between persons dealing at arm’s length; Results in misuse or abuse of the provisions of the Code; Lacks commercial substance, in whole or in part; or Carried out in a manner which would not normally be employed for bona-fide purposes

Consequence of GAAR Commissioner may declare any arrangement as impermissible avoidance arrangement and deny the tax benefit as well as treaty benefit in any manner. He may,- – disregard any part or the whole arrangement – treat the arrangement is such a manner as not to allow relevant tax benefit – disregard any accommodating party – deem connected persons to be one and the same person – reallocate among the parties revenue and expenditure involved – recharacterise any debt or equity, revenue or capital receipt /expenditure

Recommendations of the Committee 1.Onus should rest on the tax authority invoking GAAR and this should not be shifted to the taxpayer. In DTC, only onus on taxpayer is to prove that obtaining tax benefit is not the main purpose of the arrangement Other tests [abnormality, misuse and abuse of law, lack of commercial substance and non- bonafide test] are to be proved by the tax department. In Finance Bill, 2012, even this onus regarding tax benefit is omitted and thus the entire onus is on the tax department.

Recommendations of the Committee 2.Suitable safeguards and a threshold of specific amount of tax benefit for application of GAAR may be provided. A monetary threshold of tax benefit will be provided in Rules Certain safeguards already provided – Approval of CIT and GAAR panel – Reference to GAAR panel compulsory and binding – Direct Appeal to ITAT Other safeguards, clarifications will be considered in the Rules to be framed.

Recommendations of the Committee 3.Review of GAAR should be done by an independent body headed by the Chief Commissioner of Income Tax and two other members who should be independent technical persons.. Finance Bill already provides that the GAAR panel shall consist of three or more members. Members would be officers not below the rank of Commissioner One member would be Joint Secretary or above from the Ministry of Law.

Recommendations of the Committee 4.GAAR provision should be applied prospectively and grandfathering provisions may be made to protect the arrangement under the existing law. GAAR provisions are to apply prospectively i.e. for income arising on or after Grandfathering existing arrangements would imply allowing transactions through an impermissible arrangement on a permanent basis, which is not desirable. No final decision yet.

Recommendations of the Committee 5.Tax-payers may be permitted to obtain an Advance Ruling. Finance Bill proposes to provide that any resident or non-resident may approach the Authority for Advance Ruling for a ruling whether an arrangement is impermissible or not. The ruling is binding unless there is a change in relevant facts or law.

Recommendations of the Committee 6.Uncertainties with regard to applicability of tax treaty provisions should be removed so that India’s credibility as a reliable treaty partner is not affected. GAAR based on internationally agreed standards 7. The proposals should not lead to any fiscal uncertainty and avoidable litigation. – Suitable safeguards provided. 8.The conditions dealing with ‘misuse or abuse’, ‘bonafide business purpose’ and ‘lacks commercial substance’ needs to be more specifically defined. – Would be clarified through rules.

Controlled Foreign Company (CFC) A company incorporated abroad It is controlled or managed, directly or indirectly, by residents in India. Nature of income - passive Low tax jurisdiction -tax paid by such company in its jurisdiction is less than 50% of corresponding Indian tax Annual income of the company is more than Rs 2.5 million.

Consequence of CFC Post tax income of the CFC shall be attributed to residents in India in proportion to their shareholding. Such attributable income shall be deemed to have been distributed as dividends and taxable as income in the same year. Deduction allowed if such income is actually received in subsequent year. Reporting requirement: interest in any foreign entity including CFC will be required to be disclosed in the return of income.

CFC: Recommendations of the Committee 1.To clarify that foreign tax credit in respect of actual tax paid in any other territory will be included in the tax paid for the purposes of determination of low tax jurisdiction. Currently, taxes paid in home jurisdiction alone considered. If FTC included, then countries following exemption method would be adversely affected. If taxes paid in other jurisdiction is included, then whole purpose of “low tax jurisdiction” will be lost.

CFC: Recommendations of the Committee 2.A mechanism for granting tax credit should be allowed for the foreign income tax paid by the CFC. Currently, withholding taxes paid by direct CFC are allowed credit to the shareholder. In case of indirect CFC, no credit is allowed as withholding of taxes is not from payments to shareholders in India. As India follows classical system of taxation, taxes paid by any company on its income are not allowed as credit to the shareholders.

CFC: Recommendations of the Committee 3.The terms “directly or indirectly”, “dominant influence”, “decisive influence” in control test should be more precisely defined. For a foreign company to be treated as CFC, residents in India should exercise control over the company. The control can be direct or indirect, or through call or put options, or. However, the meaning of these terms shall be clarified through guidelines.

CFC: Recommendations of the Committee 4.Only such amounts of current profit which are capable of being distributed as per the applicable laws of the foreign country should be considered for taxation. No similar rule in other jurisdictions. If a tax haven provides restrictions on distribution of dividends but allows loans to be given to shareholders out of profits retained, the entire objective of CFC, being anti-deferral, would be defeated.

Advance Pricing Agreements The Board may enter into an agreement with a tax payer – to specify the manner in which arm’s length price can be determined – in relation to an international transaction – with prior approval of the Central Govt. APA may be valid upto five years Manner of determination may be any of the methods prescribed with adjustments or variations

APA: Recommendations of the Committee 1.The work of APA should be entrusted to an independent body comprising of judicial and technical members who should advise the Government. It is a voluntary agreement between taxpayer and the department. Expert advice can be taken by Govt. any time while processing APA application. Confidentiality issue if outsiders are involved.

APA: Recommendations of the Committee 2.Procedural safeguards and time limits to fortify interests of applicants may be put in place. Rules shall prescribe, inter alia, - – Pre-application and post application procedure – Class of cases and transactions to be covered – Time limit for completion of APA – Procedure for withdrawal

APA: Recommendations of the Committee 3.DTAAs already concluded should be suitably amended to include APA and in future the APAs should be included in DTAAs. APA may be unilateral (as per domestic law) or bi-lateral (as per the DTAA) Generally, bi-lateral APAs are carried out under MAP and does not require any provision in the domestic law. Any clarification regarding bi-lateral APAs may also be provided through guidelines.

Residence of a Company Current law: A company is defined as resident in India if – It is incorporated in India, or – It’s whole control and management is situated in India Definition is too narrow to cover companies incorporated abroad but practically controlled and managed from India. Scope of taxation in domestic law is narrower than treaty law which provides the criteria of “place of effective management”.

Residence of a Company Proposal under DTC: A company is defined as resident in India if – It is incorporated in India, or – It’s place of effective management is situated in India “place of effective management” is defined as a place where: – Board of Directors meeting take place regularly, or – Place where the executive directors perform their duties.

Residence: Recommendations of the Committee 1.“place of effective management (POEM)” may be redefined as a place where the key management and commercial decisions as a whole are made or where the “head and brain” of the company is situated. POEM used in OECD MC, UN MC and almost all tax treaties, but not defined any where. POEM as clarified in commentary on OECD MC may be considered.

Indirect Transfer DTC provision – income from transfer, outside India, of any share or interest in a foreign company shall not be taxable unless the fair market value of the assets in India owned, directly or indirectly, by the company are more than 50% of its global assets. Committee recommendations – To exclude small holdings in the foreign company – To exclude listed foreign companies – Exemption to intra-group restructuring outside India

Indirect Transfer Finance Bill, 2012 provision – income from transfer of any share or interest in a company or entity registered or incorporated outside India, if the share or interest derives its value substantially from the assets located in India. – Committee recommendations are under examination.

Indirect Transfer: concerns raised 1.It may lead to taxation of participatory note (PN) holders in an FII investing in India, if such PNs are traded outside India. – PN is not in the nature of any share or interest in a foreign company, hence not covered by indirect transfer provision. – As regards applicability of the GAAR provisions on the ground that PN holder has routed his investment through an FII in a favorable tax jurisdiction just to obtain tax benefit, it has been clarified that such PN holders will not be covered under GAAR (now deferred by one year).

Indirect Transfer: concerns raised 2.It may lead to taxation of a foreign investor in an India specific private equity fund, if such investor sells his interest to another non-resident outside India. – Generally, the interest of an investor in the fund is not in the nature of any share or interest in a foreign company or entity, hence not covered by indirect transfer provision. – In case the investor in such fund is treated as a shareholder, sale of interest by such investor may be covered by indirect transfer. This may be an unintended consequence which may be clarified by the Govt. of India.

Recent Investors’ Friendly Measures Reduction in rate of tax from 20% to 10% on long term capital gains on sale of unlisted securities. Exemption from long term capital gains if unlisted shares are sold under an offer for sale to public. Withholding tax rate on borrowing from abroad by way of loan or issue of long term infrastructure bonds is reduced from 20% to 5% for all sectors. Restriction on Venture Capital Fund/Company to invest in specified nine sectors only removed. Dividends received from foreign company to be taxed at a lower rate of 15% instead of 30%. Securities Transaction Tax (STT) on delivery transactions reduced by 20% (from 0.125% to 0.1%)

Discussion