25 November 2021 - Article
India’s budget for the financial year 2018-19 announced recently will be the last full budget before elections next year. It is therefore quite populist with a strong focus on fundamentals such as infrastructure, employment, healthcare and education. Although the budget does not offer special tax incentives to global investors, they are likely to stay committed to investing in India which is one of the world’s fasting growing large economies.
Investors, funds and MNCs would have to consider a number of tax risks while investing or doing business in India. International measures such as BEPS (base erosion and profit shifting), MLI (multilateral instrument) and CRS (common reporting standards) will also impact India focused cross-border structures.
We have summarized below some of the key changes announced in the 2018 budget and considerations for overseas funds, MNCs and wealthy families.
Implications for overseas funds
Long term capital gains arising after January 31, 2018 from the sale of listed securities in India will now be taxed at 10% in addition to the securities transaction tax. Foreign portfolio investors including hedge funds, sovereign wealth funds and other market participants may be disappointed with this change and its impact on effective return on investment. Short term gains will continue to be taxed at 15%.
The amendment of India’s tax treaties with Mauritius, Singapore and Cyprus removed the capital gains exemption that was previously available to funds and investors resident in these countries. Investors based in Netherlands, France, Belgium, Spain and Denmark may however benefit from the treaty exemption for gains from the sale of securities that are less than 10% in an Indian company.
It is unclear whether the additional 10% tax will drive funds to shift allocations to other markets that do not tax financial portfolio gains. The government’s expectation is that India’s strong economic prospects will continue to attract investments. Funds seeking to restructure to a jurisdiction like Netherlands should plan carefully after considering anti-conduit rules and substance requirements.
Funds investing into India should also be cautious about new Indian tax rules that could potentially trigger taxable presence or permanent establishment (PE) in India. For example, there is a risk when a sub-advisor of the fund based in India is actively involved in negotiating deals that are ultimately signed or concluded by the fund overseas. With the signing of the MLI, many of India’s tax treaties also reflect a similar lower threshold for creating a PE. Funds based in Hong Kong should be cautious of this potential risk especially in the absence of a tax treaty with India. The new rules may not impact the Singapore and Mauritius tax treaties, but funds based in these countries could face risks if treaty relief is denied as a result of applying general anti-avoidance rules (GAAR) which were introduced last year.
Overseas PE and VC funds were hoping to get further clarity on the application of GAAR as well as relief against the indirect transfer tax risk arising on redemptions by investors or shareholders. To their disappointment, the budget does not address these issues, although a clarification was issued in November 2017 providing such relief to a limited category of investors in specified Indian funds.
Funds and investors should also be conscious of their obligations to file tax returns in India. The budget proposes to prosecute companies (including overseas entities) for failing to file tax returns even if there is no taxable income in India- for instance, because of tax treaty relief.
Implications for tech companies and MNCs
Typically, global enterprises that do not have a fixed base, agent or PE in India are not taxed on income received from Indian customers. The budget now proposes to tax such companies if revenues from India and the size of their Indian customer base meets a threshold that will be prescribed. The corporate tax rate for overseas companies is 40%. This proposal follows the OECD’s suggestion that countries may consider implementing lower thresholds to tax tech companies who are able to generate significant revenues from a market without having a presence on the ground.
For many global tech companies, the concept of ‘digital PE’ envisaged in this proposal can be problematic, especially since India is one of their largest and fastest growing markets. The proposal also does not limit itself to digital transactions and is broad enough to impact other enterprises transacting with India. Several tech companies that do not have PEs in India are already grappling with the 6% equalization levy on digital advertisement revenues from Indian customers. The recent implementation of GST in India has also created administrative and compliance challenges for the sector.
While the budget proposal amends domestic law, India’s tax treaties generally envisage a higher threshold for PE which may provide relief in certain cases. However, structures for holding intellectual property or intangibles should take into account GAAR and other treaty anti-abuse rules which can result in denial of treaty benefits. Investors should also comply with tax return filing obligations while claiming treaty relief.
On a positive note, the budget reduces the corporate tax rate for domestic companies earning less than INR 2.5 billion (around US$ 40 million) from 30% to 25%. A large number of small and medium sized companies in India will benefit from the reduced rates.
A few budget proposals are directed at corporate restructurings. Distributions under certain corporate merger plans which were designed to circumvent the 15% dividend distribution tax (DDT) on accumulated profits of the merging company will now be taxed. The recipient of assets in a transfer between parent and subsidiary will be exempt from tax. Some relief in relation to loss carry forwards and minimum alternative tax (MAT) has also been provided to loss making entities. Overseas companies engaged in certain activities like shipping, exploration of mineral oils and operating aircrafts, which are subject to a presumptive tax regime, have also been given relief from MAT.
The budget proposes changes to the rules for country-by-country (transfer pricing) reporting including a longer window of 12 months from the relevant accounting period for filing reports, and a requirement for an Indian subsidiary to be the reporting entity if the parent is not required to file reports overseas.
Other recent developments include regulatory reforms liberalizing investments into Indian holding or investment companies and companies engaged in single brand retailing. Share issuances against pre-operational expenses or in exchange for capital equipment and machinery is also now allowed without regulatory approval for most sectors.
Implications for wealthy families
The tax on long term capital gains will affect founders and shareholders in Indian listed companies (or companies to be listed in the future). Those who seek to rely on the Singapore tax treaty exemption for pre-April 1, 2017 shareholdings should consider anti-avoidance rules and forex control limitations while shifting out of India.
Although there have been rumours about re-introduction of inheritance tax in India, it is yet to materialize. However, for many other reasons including succession, asset protection and philanthropy, wealthy families have been actively planning their global assets using various onshore and overseas trust structures as well as more sophisticated structures such as private trust companies and family offices.
The budget proposes to discourage certain actions by tax exempt charities in India. Cash payments in excess of INR 10,000 and 30% of any payment made by the charity without withholding applicable tax would now be taxed.
Regulatory changes in November 2017 allowed non-resident Indians (NRIs) to transfer their Indian securities to a non-NRI person or entity. With this flexibility, some NRIs have considered re-structuring their Indian shareholdings or transferring such securities to overseas trust structures for succession planning.
On a concluding note
Regulatory reforms, strong fundamentals and economic growth prospects are likely to keep investors interested in the India story.
The budget, however, may not excite investors and misses the opportunity of resolving various tax related uncertainties and challenges that they face. While navigating these issues, investors have to plan strategically and with the understanding that, today, tax planning is also a matter of reputation management.