India’s Finance Act 2015: What You Need to Know

In May, President Pranab Mukherjee gave his assent to Prime Minister Narendra Modi’s first full budget. The Finance Act, part of the 2015 India Budget, addresses several areas of concern for foreign investors, but falls short of clarity in many respects.

Specifically, the Finance Act addresses the definition of tax residency for companies, applicability of minimum alternative tax provisions, deferral of the general anti-avoidance rules, a reduction of withholding tax rate on royalties and fees for technical services and an increase in the services tax.

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Tax Residency

Properly determining tax residency is critical for foreign companies doing business in India. A spate of recent court cases challenging the tax residency status of foreign companies spurred the government to enact changes clarifying the law.

The Finance Bill as introduced provided that a company would be considered a resident of India if its place of effective management (POEM) was in India “at any time” during the year. This wording would potentially cause a company to qualify as a resident in India even if it were to have a POEM in India for only one meeting during the year. Under this scenario, a foreign company with Indian operations could be deemed a resident in India, which could lead to taxation in India on the company’s worldwide income.

The Finance Act as enacted omits the phrase “at any time” and now applies the POEM standard to the entire year. Ambiguity remains, however, in the interpretation of the definition of POEM, as it is unclear whether Indian courts will follow the Organization for Economic Co-operation and Development (OECD) definition.

Minimum Alternative Tax

Following criticism of the multiple minimum alternative tax assessments (MAT)on foreign institutional investors, the Lok Sabha (or lower house of parliament) introduced a change to the original bill. The change clarifies the government’s position on the applicability of the MAT to foreign companies.

The Finance Act extends the explicit exemption from the MAT to any foreign company that earns income in the form of capital gains on securities, interest or royalties and fees for technical services. The exclusion applies as long as the tax payable on such income is less than 18.5 percent; that is, the rate of the MAT. However, the Finance Act stops short of providing retroactive relief for foreign investors that received tax notices on MAT applicability to past gains on investments.

RELATED: The Implications of India’s MAT for Foreign Investors

General Anti-Avoidance Rules

Another timely provision of the Finance Act is the deferral of the general anti-avoidance tax rules (GAAR). GAAR represents a major area of concern and uncertainty for foreign investors doing business in India; the government has not yet issued guidelines explaining its implementation.

The Finance Act defers GAAR’s effective date so that it applies to transactions taking place on or after April 1, 2017. This is the fourth time that the government has postponed implementation. As written, GAAR provisions would give tax authorities greater powers to examine cross-border transactions for signs of tax evasion. Such powers would include the power to override all tax treaties and to disregard, look through, or re-characterize business arrangements that are deemed to be impermissible avoidance arrangements.

Unfortunately, the government stopped short of permanent deferral of the provisions. Nor has the government issued promised GAAR guidelines. As a result, companies are still in the dark as to whether – and how – to prepare for GAAR implementation.

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Withholding Tax Reduction

The Finance Act as enacted carried through with a provision to reduce the base withholding tax rate on royalties and fees for technical services paid to a foreign company from 25 percent to 10 percent plus education cess and surcharge. A ‘cess’ refers to a tax which is earmarked for a particular purpose.

This provision is a welcome change for taxpayers based in countries with double taxation avoidance agreements which provide for a greater than 10 percent withholding tax on royalties and fees for technical services. By applying the provisions of the Indian tax law, the base rate of withholding tax will reduce to 10 percent. This change should have the effect of encouraging technology flow into India, if some clarity is provided in other critical areas addressed in this article.

Service Tax Rate Increase

The Finance Act also codifies an increase in the service tax ratefrom 12.36 per cent (including cess) to 14 per cent. The new rate subsumes the educational cess and secondary and higher secondary education cess that was levied over and above the 12 percent tax rate. The increase in service tax is applicable for all services except for those on the ‘negative list’. The list was updated in the final budget.

Welcome Changes, but Less than Clear

Taken together, the changes and clarifications of the Finance Act are business-friendly measures. However, foreign companies doing business in India should not lose sight of the remaining questions when approaching corporate tax planning in India.          

This article was first published on India Briefing.

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