There is a growing concern in the international business community about the lack of certainty and transparency in the application of income taxes to their business operations in India.
The general impression is that the administration of tax laws in India is often arbitrary and deviates from well-accepted international norms and interpretations. Executives also are concerned about the time- consuming nature of litigation and dispute resolution in the country.
In order to improve the situation, Ernst and Young regularly participates in discussions with the policy-makers in the Indian Ministry of Finance to communicate the concerns of the international business community, says Gaurav Taneja, national tax director and partner of Ernst & Young in India.
The objective of the discussions is to make the authorities aware of several factors, he said, namely that:
* A gap exists between Indian and international income tax practices
* There is an economic cost from the current practices in the form of lost investment and employment opportunities;
* Simpler and clearer tax policies and interpretations and simplification of the dispute resolution process would facilitate an investor-friendly environment, yield more revenues, and reduce administration and compliance costs.
“The ultimate objective is to assist in the development of credible positions which are seen to be in the overall interest of the Indian government and the non-domestic corporate tax- payers,” said Mr. Taneja, whose firm states that it has the largest integrated tax advisory team in India of more than 1,000 dedicated professionals.
Changes to the tax policies were announced on February 29 in the nation’s Budget and incorporated into the Finance Bill, 2008.
However, says Mr Taneja, “the future of India’s tax policies cannot be foreseen based on the provisions of the Finance Bill alone. Over the years, the corporate tax rate has stabilised with the basic corporate tax rate being 30 percent. Perhaps for the first time, the direct tax collections have surpassed those from indirect tax such as excise, the hallmark of any tax-developed regime. Thus, Indian tax policies do need to take into account the changing environment.”
Indian Finance Bill 2008
The Economic Times in India believed that the Indian Finance Minister’s Budget was “crafted with an eye on the upcoming general elections, rather than giving impetus to the growth story.” The news journal noted that there were some “positives” for certain sectors such as auto and education, but was “rather disappointing” for information technology and banking.
Ernst & Young’s Mr. Taneja, meanwhile, pointed out some of the new taxation issues that are proposed in the Finance Bill 2008 as announced during the Budget.
For example, there has been no change on the corporate tax rate, but one of the most significant proposed changes has been in the manner of computing the book profits for the “minimum alternative tax” levy (MAT).
Presently under the MAT provisions, if the tax payable on total income computed under the normal provisions of the Income Tax Act 1961 (Act) is less than 10 percent of the book profits of the company, then MAT is levied at 11.33 percent on such book profits. (Book profits are the net profits shown in a profit and loss account prepared as per the Companies Act, 1956 as increased or reduced by certain adjustments provided for in the Act.)
However, says Mr. Taneja, the Finance Bill proposes to add back any deferred taxes and provisions to arrive at the adjust book profits. “Moreover, this amendment is proposed to be retrospective from April 1, 2001,” Mr. Taneja added. “By doing so, the Bill has sought to overturn a few judicial decisions and may lead to reopening of tax cases in several instances.”
However, the Finance Bill gives some respite from dividend distribution tax (DDT), says Mr. Taneja. Shareholders have been exempt from paying tax on dividends paid by Indian resident companies, but the companies have had to pay a “dividend distribution tax” of 16.99 percent. “This has lead to a cascading impact in the case of multi-tier group entities,” says Mr. Taneja. “The effective tax burden is high since DDT is a sunk cost and is not allowed as a deduction while computing taxable business profits.”
The Finance Bill provides some respite by proposing that the amounts of dividend paid by an Indian resident company (provided it is not a subsidiary of any other company) will be reduced by the amount of dividend received by it from its Indian subsidiary in the same financial year. This provision, however, does not benefit a subsidiary in India of a foreign company or more than a two-tiered company structure.
Also in the Finance Bill are certain proposed amendments regarding administrative and procedural provisions which may give the tax authorities further leeway on the issue of notices at the summary (initial) assessment level and the initiation of penal proceedings without giving any reasons. “One proposal which has come in for much criticism is that where a taxpayer has appeared in any proceeding or cooperated in any inquiry relating to an assessment, it shall be “deemed” that the notice from the tax department was duly serviced on him and was not invalid,” said Mr. Taneja. “In other words, he cannot cooperate without prejudice to the right to object subsequently as regards the invalid status of the tax notice.
I.T. industry taxation
Meanwhile, the Budget proposals were not favourable to the I.T. industry, according to Mr. Taneja. Under the present taxation scheme, the I.T. sector operating through undertakings set up under various government schemes such as the Software Technology Park, Electronic Hardware Technology Park Schemes –enjoy a complete direct tax exemption or tax holiday on earned export profits. Such undertakings are also eligible for certain indirect tax benefits such as exemption from payment of customs duty on imports. However, while the indirect tax benefits are slated to continue for companies operating out of such undertakings -. the tax holiday has a sunset clause of March 31, 2009 when it would be due to expire. Perhaps owing to India’s World Trade Organization commitment, this tax holiday period has not been extended in the 2008 Budget, even though the depreciating dollar against the rupee has hit hard the IT exporters.
“The Budget proposals have also been largely unfavourable to the IT Industry on the indirect tax front as well,” said Mr. Taneja. The excise duty on packaged computer software has increased from 8 percent to 12 percent. There is also a proposal to withdraw the service tax protection available to the IT industry by bringing ‘information technology software services’ within the service tax net (taxable at 12.36 percent). “This proposal may actually be beneficial to exporters who will now be able to claim a refund of service tax/excise duty paid on input services/inputs,” he added.
There could have been a more focused set of incentives provided to the IT industry targeted at the continued growth of the IT sector, Mr Taneja adds. “In our view, the Budget could have provided an extension of the tax holiday benefits for at least one year for the smaller players if not for everyone in the industry,” he said.
News reports claim that India may face stiff competition from other countries such as Vietnam for the “Business Process Outsourcing (BPO)” sector which sets up outsourcing companies in nations which offer tax holidays, free space, and reimbursement for salaries and training costs.
However, it is too early to say how the impending sunset clause on India’s tax holiday will affect the growth in India’s BPO sector, says Mr. Taneja.
“Over the years, India has transformed from being a pure outsourcing destination to an innovation or knowledge hub,” he said. “Unlike BPO which is regarded as procedure driven, Knowledge Process Outsourcing (KPO) is more knowledge-driven. Nasscom, an IT industry association, estimates that this sector is poised for a 45 percent per annum growth till 2010 and may touch $17bn by that date. According to Nasscom, engineering, design, biotech and pharmaceuticals are some key areas in the KPO sector. Thus, while it may be possible that other countries may attract investments into BPO operations, by reinventing the wheel India appears to be still capable of attracting investments.” It is also interesting that some large Indian resident companies are migrating their low-value operations to cheaper jurisdictions, Mr Taneja added.
Meanwhile, prior to the Budget, there was talk of India’s finance minister introducing anti abuse provisions in the Finance Bill, primarily to take care of treaty abuse, especially as regards the tax treaty with Mauritius,
In the recent past, the practice of routing investments into India through jurisdictions like Mauritius and Cyprus, which contain favourable capital gains tax clause in the treaties, has been a much debated topic,” said Mr Taneja. “In these cases, the sale of shares of Indian companies do not attract capital gains tax in India. Further Mauritius and Cyprus also do not levy any tax on such capital gains.”
However, the Finance Bill, 2008, has not introduced any unilateral amendment which could impact foreign investments. “Fortunately, there has been no knee jerk reaction,” said Mr Taneja. “While interpretation of tax treaties may continue to result in litigation at the lower judicial levels, by and large, India is committed to honouring its treaty commitments.”
Media reports have highlighted efforts at renegotiation of these tax treaties – those with Mauritius and Cyprus, but the outcome of such negotiation is still unclear, as renegotiation is a bilateral act based on consensus, Mr. Taneja said. “The Indian Government may completely want to do away with the favourable capital gains tax clause in these tax treaties similar to the recently amended UAE tax treaty. Alternatively, they may want to introduce specific Limitation of Benefits clause to avoid misuse of tax treaties similar to the one introduced in the Singapore tax treaty,” he said.
On another matter, Mr. Taneja has concerns about the treatment of “permanent establishments (PE)” under Indian law. “Despite various judicial precedents, there is a lack of clarity and consistency at the tax assessment stage, especially by lower level tax officers, as regards creation of a PE in India upon deputation of expatriate employees, limited presence in India such as through a representative office, or performance of activities in India by agents,” said Mr. Taneja. “The attribution of appropriate profits to PE of the foreign enterprise in India has also suffered arbitrariness.”
Although, domestic tax laws (Rule 10) provide some guidance for the revenue authorities, these may not be objectively applicable in all situations where the PE would have performed limited role in the over-all business transaction, he said. Owing to the aggressive stand of the tax authorities, especially at the lower levels, it has now become very imperative for MNEs operating in India to review their existing business models to determine the extent of PE risk that they face and the risk associated with the subsequent income attribution to such PE by the tax office, he said.
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