On 1st February 2017, the Finance Minister Arun Jaitley presented the Budget 2017. On a personal level, most taxpayers expected a big cut in the taxes but they were happy with the rebate that the taxpayers got. Coming to the business front, many companies have spread across tax jurisdictions and the main concern was taxing revenues from them based on the existing tax rules. Budget 2017 brought a lot of changes to address the challenges and bring clarity to the international taxation.
The Organisation for Economic Cooperation and Development and the G20 countries in the Base Erosion and Profit Shifting (BEPS) project have set out various recommendations to put an end to the tax avoidance by businesses. India has been extensively engaged in the implementation of the recommendations.
Interest deduction Rules
The major proposal of the budget is the introduction of rules which would be limiting the interest that can be deducted in computing a company’s profit for tax purposes. This rule will be effective from April 2018. This rule is primarily designed to address the cross- border profit shifting through excessive interest payments.
The budget also proposes to insert a new section 94B in the Income Tax (IT) Act. According to this new section, the interest claimed by an entity to its related parties shall be restricted to 30% of its earnings before interest, taxes, depreciation, and amortization or the actual interest paid or payable to the related parties, whichever is less. This section would apply to an Indian company or a permanent establishment (PE) of a foreign company that is the borrower paying interest in respect of any form of debt issued to a nonresident or to a PE of a non- resident and who is related to the borrower.
If the interest expenditure is of INR10m (USD148,372) or more, then only the rules of this section will be applied. This will thus target only large interest payments. Banks and insurance business are proposed to be excluded from the ambit of the new rules.
Adjustments in the transfer pricing provisions
The budget 2017 proposes to insert a new section 92CE in the IT Act. This section provides that a taxpayer would be required to carry out some secondary adjustments where a primary adjustment to transfer price has been made under certain circumstances.
This section will align India’s transfer pricing provisions with the OECD transfer pricing guidelines and international best practices. The secondary adjustment rule if enacted would make India a part of the leading economies of the world.
The new provision would apply only if the primary adjustment is INR10m (USD 148,372) or more, and the excess amount attributable to the adjustment is not repatriated to India within the prescribed time.
Indirect transfers
The budget 2017 contains a welcome clarification so far as the tax treatment of indirect transfers of assets under Section 9(1)(i) of the IT Act is concerned.
Section 9(1)(i) provides that all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situated in India, shall be deemed to accrue or arise in India.
The Finance Act 2012 inserted explanation 5 in Section 9(1)(i). It clarifies that an asset or capital asset, being any share or interest in a company or entity registered or incorporated outside India, shall be deemed to be situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.
The budget proposes to exempt Category I and II foreign portfolio investors from the indirect transfer provision. Also, an indirect transfer provision would not apply in the case of redemption of shares or interests outside India. These changes are proposed to take retrospective effect from April 1, 2012.
Offshore Funds
There are a special tax regime prevailing for offshore funds (“eligible” investment funds) under Section 9A of the IT Act. The budget proposes a few modifications in the same. The fund management activity carried out through an “eligible” fund manager acting on behalf of the offshore fund shall not, subject to certain exceptions, constitute a PE in India of the fund.
The budget also proposes to modify one of the conditions of the special taxation regime for offshore funds under section 9A to provide that the maintenance of minimum fund size (INR1bn) would not be necessary for the year in which the fund is being wound up.
Other Changes
- The budget 2017 seeks to reduce the compliance burden of domestic transfer pricing provisions by restricting, with effect from April 2017.
- There was a requirement of publishing a notification in the Official Gazette to clarify the meaning of a term left undefined in the IT Act or in tax treaties, for the purposes of Sections 90 and 90A of the IT Act. The budget also proposes to do away with this.