Foreign institutional investors could not be happier as the revised discussion paper on direct taxes code clarified that the domestic code would not override the double taxation avoidance agreements.
This could come as a huge relief as majority of the FIIs operating in India are registered in tax havens. The discussion paper also removed the ambiguity on income classification for tax computation.
“It is proposed to provide that between the domestic law and relevant DTAA, the one which is more beneficial to the taxpayer shall apply,” noted the discussion paper.
This is a shift from the earlier stand, as the DTC clearly said that neither the DTAA nor the code would have a preferential status and in cases of conflict ‘the one that is later in point of time shall prevail”.
India, incidentally, has signed bilateral tax avoidance treaties with countries like Mauritius, Isle of Man, Seychelles and Cayman Islands, among others.
“This is positive for the FIIs as the treaty over-riding provisions have been done away with,” said Siddharth Shah, head – funds practice, Nishith Desai Associates.
“So, in a sense it is good but we need to wait for the fine print. But it will surely provide some comfort to the FII community.”
“It is proposed that the income arising on purchase and sale of securities by an FII shall be deemed to be income chargeable under the head ‘capital gains’,” said the discussion note.
This, according to experts, would help in avoiding unnecessary litigation as many FIIs were classifying their income as ‘business income’ to claim total exemption from taxation in the absence of a permanent establishment in India.
Sameer Gupta, director at Ernst & Young, said given that characterisation of income from sale of securities was driven by circumstances, it had the potential for litigation and to that extent, the provision deeming income of FIIs on sale of securities as capital gains would provide clarity to foreign investors.
Also, the proposal to revert to a concessional tax treatment for listed equity shares and units of equity-oriented mutual funds held for more than a year was a right step, but would fall short of market expectations, he said.
Govt scraps plan to make DTC override tax avoidance treaties
The government has dropped its plans to make the direct taxes code (DTC) override double taxation avoidance agreements (DTAAs). It has proposed that the new law would have preferential status over an existing tax treaty only in three situations.
In the revised DTC draft, the finance ministry suggested that the DTC would be the basis for levying tax, if authorities invoked the provisions of either the General Anti-Avoidance Rule (GAAR) or those related to Controlled Foreign Corporations (CFCs). The third condition would be when branch profit tax is levied.
“Essentially, what the government is saying is that the existing system will continue, except under three specific circumstances. So, it is quite welcome,” said Dinesh Kanabar, deputy chief executive officer and chairman – tax for KPMG’s operations in India.
The existing provisions of the Income-Tax Act provide that between domestic law and the relevant DTAA, the one which more beneficial to the taxpayer will apply. One of the exemptions to this is taxing foreign companies at a rate higher than that for domestic companies.
“This limited treaty override is in accordance with the internationally accepted principles. Since anti-avoidance rules are part of the domestic legislation and they are not addressed in tax treaties, such limited treaty override will not be in conflict with the DTAAs. Further, this will not deprive any taxpayer of any intended tax benefit available under the DTAAs,” the revised draft, released this evening, said.
The move to make DTC override existing DTAAs, unless specifically notified, was proposed as many countries with which India had pacts, such as Mauritius, were unwilling to renegotiate the provisions of these treaties. So, it proposed in case of a conflict between the provisions of a treaty and DTC provisions, the one later in point of time would prevail.
The industry complained this would result in a higher rate of taxation on royalty, fees for technical services and interest income, which were taxed in the source country at a concessional rate according to DTAA provisions. Uncertainty over the cost of doing business in India would also affect foreign direct investment, it was argued. Besides, tax consultants said the proposal was against international norms.
The consultants said that by making DTC override the tax treaties in cases where GAAR was invoked, the government could effectively deal with cases such as companies using the Mauritius route to avoid tax payment.
The government has dropped its plans to make the direct taxes code (DTC) override double taxation avoidance agreements (DTAAs). It has proposed that the new law would have preferential status over an existing tax treaty only in three situations.
In the revised DTC draft, the finance ministry suggested that the DTC would be the basis for levying tax, if authorities invoked the provisions of either the General Anti-Avoidance Rule (GAAR) or those related to Controlled Foreign Corporations (CFCs). The third condition would be when branch profit tax is levied.
“Essentially, what the government is saying is that the existing system will continue, except under three specific circumstances. So, it is quite welcome,” said Dinesh Kanabar, deputy chief executive officer and chairman – tax for KPMG’s operations in India.
The existing provisions of the Income-Tax Act provide that between domestic law and the relevant DTAA, the one which more beneficial to the taxpayer will apply. One of the exemptions to this is taxing foreign companies at a rate higher than that for domestic companies.
“This limited treaty override is in accordance with the internationally accepted principles. Since anti-avoidance rules are part of the domestic legislation and they are not addressed in tax treaties, such limited treaty override will not be in conflict with the DTAAs. Further, this will not deprive any taxpayer of any intended tax benefit available under the DTAAs,” the revised draft, released this evening, said.
The move to make DTC override existing DTAAs, unless specifically notified, was proposed as many countries with which India had pacts, such as Mauritius, were unwilling to renegotiate the provisions of these treaties. So, it proposed in case of a conflict between the provisions of a treaty and DTC provisions, the one later in point of time would prevail.
The industry complained this would result in a higher rate of taxation on royalty, fees for technical services and interest income, which were taxed in the source country at a concessional rate according to DTAA provisions. Uncertainty over the cost of doing business in India would also affect foreign direct investment, it was argued. Besides, tax consultants said the proposal was against international norms.
The consultants said that by making DTC override the tax treaties in cases where GAAR was invoked, the government could effectively deal with cases such as companies using the Mauritius route to avoid tax payment.
Foreign arms of Indian firms may come under tax net
The revised discussion paper on the Direct Taxes Code (DTC) has proposed to tax the income of foreign subsidiaries of Indian companies. It also suggests that a company incorporated outside India will be taxed only when its management is taking decisions in India.
As an anti-avoidance measure, in line with internationally-accepted practices, the revised draft also proposed to introduce Controlled Foreign Corporation (CFC) provisions to ensure that passive income earned by a foreign company controlled directly or indirectly by a resident in India is taxed by authorities here.
“(In cases) where such income is not distributed to shareholders resulting in deferral of taxes, shall be deemed to have been distributed. Consequently, it would be taxable in India in the hands of resident shareholders as dividend received from the foreign company,” said the discussion paper.
The government’s revenue collections are being affected in the absence of CFC rules as many Indian companies avoid or defer bringing back the profits to the country, and instead, deploy the funds for overseas expansion. This results in delayed or non-payment of taxes on the profits made by the foreign arm.
“The revised discussion paper suggests that the profits of a foreign subsidiary will be taxed in the hands of an Indian company. It is not clear what percentage of these profits will be taxed and how many layers will be taxed. Some of the global companies have explored creation of layers to mitigate tax,” said Pranay Bhatia, associate partner, Economic Laws Practice.
The revised paper also made changes to the concept of residence in the case of a company incorporated outside India. The DTC had proposed that a foreign company will be treated as resident in India if, at any time in the financial year, the control and management of its affairs is situated “wholly or partly” in India (it need not be wholly situated in India, as at present).
“Under the current law, the global income of a company controlled and managed wholly in India is taxed in India. This is the reason many foreign companies do not want the control and management of its affairs in India. DTC changed it further to ‘wholly or partly’ managed in India. This means even if one of board meetings of a company takes place in India, its global income could be taxed here. This has been proposed to be rationalised to tax the companies having ‘place of effective management in India’,” Bhatia said.
The word ‘partly’ used in DTC set a very low threshold for regarding a foreign company as a resident in India. Apprehensions were raised that it could lead to a foreign multinational company being held as resident in India on the ground that some activity like a single meeting of the board of directors is held in India.
Also, a foreign company owned by residents in India could be held to be a resident in India as part of its control may be in the country.
“It has been represented that this will result in uncertainty in taxation and will impact foreign direct investment into India,” said the discussion paper.
