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Budget 2016: The fine print

Budget 2016 carries with it plenty of hype and expectations despite the slowing global economy and a gloomy picture presented for the rest of the world. In that context, India has been a beacon of hope delivering 7.6% growth in the past year with projections for similar levels in the coming year as well. A lot therefore rode on the budget  pronouncements of the government. Will they be able to For what it is worth, the government has carried forward on the path towards reforms via this budget by proposing relaxation of foreign direct investment norms in certain sectors while sticking to the target fiscal deficit figure of 3.5% .

The government has followed up on its promise of reducing corporate tax rates, albeit only for limited subset. They have also actively reduced various deductions or have announced sunset clauses for other deductions to simplify the tax structure in the long run.

Start-ups have gained, as announced in the startupIndia plan, by way of tax incentives. Place of Effective Management provisions have also been deferred for a year. At the same time the government has reaffirmed its commitment to general Anti avoidance Rules (GAAR)

We hope you find the comprehensive analysis of the budgetary provisions useful. Should you have any specific queries regarding the budget feel free to reach out to us. Our team will be happy to help you.

Direct Tax

Corporate tax rates tweaked

The general rates for corporate tax shall continue to be 30% however the budget has introduced two new rates for the following companies:

  • Small companies, with turnover in the financial year 2014-15 not exceeding INR 50 million can pay tax at a rate of 29% plus surcharge and cess
  • Companies which are set up on or after March 1, 2016 engaging solely in the business of manufacture or production, will be given the option to be taxed either at the rate of 30% or at the rate of 25% in which case they will be able to claim any profit or incentive linked benefits under the act.

Increased Surcharge on Non corporate assessees

The finance bill proposes to raise the rates of surcharge applicable on Individuals, Firms, LLPs having incomes above Rs 10 million from their current rate of 12% to 15% of the tax on the income of such assessees.

Support measures for Startups

In line with the pronouncements of the #StartupIndia initiative, the government has announced several measures that are certainly going to add wind to the sails of many startup businesses in India.  To be eligible for these incentives the startup must :

  • Be a company incorporated on or After 1.4.2016 but before 1.4.2019
  • Have annual turnover equal to or below Rs 250 million in any preceding financial year between 1.4.2016 and 31.3.2021
  • Should be certified by the inter-ministerial board, a part of the DIPP.

Incentives available for startups include deduction equal to 100% of the profits and gains earned the eligible startup. The deduction shall be available for 3 consecutive assessment years out of 5 at the option of the startup, Minimum Alternative Tax (MAT) would however still be applicable.

Other measures designed to help and promote startups include exemption from capital gains earned from transfer of property if such capital gains are invested in shares of company. This is an addition exemption of up to Rs 5 million from Capital gains if long term capital gains are invested in units of specified funds and such funds remain invested in such funds for three years.

We think these measures will definitely help startups , however the policy measures announced during Startup India included registered partnerships within the ambit of a startup. However the tax proposals do not seem to reflect the same.

Increased Scope for presumptive taxation of Non corporates

To make doing business easier for small businesses and to encourage greater compliance with tax laws, the government has increased the threshold limit for applicability of presumptive taxation under section 44AD.

Assessees with incomes below 20 Million can now file their returns based on a presumptive rate of profit (above 8%) without the need to maintain books of accounts. This will provide relief from compliance costs to many a business person and will certainly make doing business easier for them.

A similar facility has been extended to professionals earing incomes up to Rs 5 million by way of section 44ADA . Such professionals will be able to file returns of income on presumptive basis on estimated profits of 50% of gross receipts.

Dividends Received in Excess of Rs 1 million Taxable

Individuals, HUFs, Firms and LLPs receiving income from dividends in excess of Rs 1 million from a domestic company shall have to pay an additional tax on such dividend income at the rate of 10%.

This shall be in addition to the dividend distribution tax paid by the company at the time of the dividend distribution and the taxes on profits already paid by the company before the announcement of the dividend.

We find this cascading system of tax quite difficult to agree with, the further the act does not allow for setting off the costs incurred to earn these dividends against such dividends earned.

STT on options increased to .005% from .0017%

Securities transaction tax (STT) in cases where the option has not been exercised has been increased to 0.05% from 0.017% of the option premium. This should lead to additional revenue for the government provided it does not cause a steep drop in volumes of options traded.

Tax collection at source (TCS) to be applicable on purchase of Cars

With effect from 1.6.2016 the seller of the following goods and services shall have to collect 1% of the total consideration as Tax collected at source. This is to help the government detect consumption and link it with incomes as filed by the assessess.

  • Sale of Motor vehicles of value exceeding Rs 1 million
  • Sale in cash of goods ( other than jewelry) or Services ( on which no TDS is deducted) in excess of Rs 2 lakhs

Phasing out of Deductions

As announced in the budget of last year, the finance minister has proposed to gradually phase out deductions to simplify the tax code.

The deduction as specified in section 10AA, section 35 ( for certain cases), 35AC, 35AD, 35CCC, 35CCD, 80-IA, 80-IAB, 80-IB are all proposed to be phased out by 1.4.2020.

The aim of the government is to allow the existing beneficiaries of the deductions to have a weaning off period and allow for the deductions to run their course before they are discontinued. This seems to be a logical step in our opinion.

Changes to the Withholding tax regime for non residents

As per section 206AA of the Income tax Act, non resident who earn any income from India are required to quote PAN to be able to use the standard rates of TDS deduction as opposed to the peak rate of 20%. Often they do not have a PAN and therefore find themselves at a financial loss. The government has proposed to amend the provisions of section 206AA to allow non company recipients to be able to receive interest on long term bonds and other incomes subject to conditions to be prescribed by the government without the need for a PAN.

This will certainly help non residents doing business with India and the higher burden of withholding taxes shall no longer be a burden anymore.

Lower rates of capital gains for unlisted securities

In a move that is surely going to bring cheer to PE funds and generally spur M&A acticity. It has been proposed in the budget to reduce to 10% the tax rate on the transfer of shares in an unlisted private company where such shares are transferred by non residents.

Reduction in holding period for Unlisted securities

The finance minister announced in his budget speech his intention to reduce the period of holding of unlisted securities from 3 years to 2 years to be eligible for taxation as long term capital gains (LTCG). Since such gains are taxed at lower rates and allow for indexation it was sure to please many shareholders. However the proposal does not find itself included in the fine print of the Finance Bill itself. We hope and assume that this omission shall be remedied before the passage of the bill into law.

Distributed income and buybacks under greater tax net

The finance bill contains proposals to widen the definition of “buyback” to include buyback of shares in accordance with companies act 2013. This will also include capital reductions. Similarly the concept of “distributed income” has also been redefined for a wider scope in taxation.

Patent tax Regime ushered in

The finance minster has proposed a new taxation regime whereby worldwide incomes received on account of royalty against a patent developed and registered in India will be taxed at a concessional rate of 10%.

Royalties for this purpose include lump sum payments but do not include any consideration chargeable to tax under the head capital gains. No expenditure or allowance in respect of such royalty shall be allowed under the act.  For the purposes of this provision“developed” has been defined to mean “the expenditure incurred by the assessee for any invention in respect of which patent is granted under the Patents Act, 1970″. The affect of this proposal on patents which have been applied for but not granted has not been explored in the budgetary proposals.

This proposal is aimed at encouraging innovation in India as well as ensuring that innovations are registered and maintained within India and no intellectual property drain takes place.

Equalization Levy imposed on online advertisements

It has been proposed to levy a “equalization levy” on consideration for specified services received or receivable by a non resident from Indian residents or non-residents having a PE in India.

At this juncture specified services have been defined to be online advertisement, any provision for digital advertising space or any other facility or service for the purposes of online advertisement and includes any other service as may be notified by the Central Government in this behalf”.

More information on this levy can be found on our post here

Country by Country reporting Introduced

In line with many other jurisdictions India too have introduced the concept of country by country reporting for large corporations. Proposed to implemented first by multinational corporations earning revenues above euro 750 million are having an Indian parent, the reporting standards require the corporations to submit :

  • Revenues, profits before tax, income tax paid and accrued;
  • Total employment, capital, accumulated earnings and tangible assets in each tax jurisdiction;
  • Identification of the entity doing business in a particular tax jurisdiction and a description of its business activities

For each country that they operate in. Further, Indian resident subsidiaries in an MNE group having a non-resident parent are required to disclose the country of residence of the parent to the Indian income tax authorities.

MAT relief for foreign investors is finally here

The government has proposed to amend section 115JB , retrospectively on might add, to clarify that the section did not apply to FIIs. This is in line with the report of the committee headed by Justice A.P. Shah. Therefore, section 115JB has been suitably amended to provide that MAT shall not apply to a foreign company with effect from 1.4.2001 if:

  • The foreign company is a resident of a country with which India has signed a Double Taxation Avoidance Agreement and does not have a permanent establishment in India; or
  • The foreign company is a resident of a country with which India has not signed a Double Taxation Avoidance Agreement and is not required to seek registration under the company law in force in India.

this will provide relief and certainty to FIIs and close the debate around applicability of MAT for good.

Introduction of Direct Tax Dispute Resolution Scheme

A new concept that was proposed by the honorable finance minister was that of the Direct Tax Dispute Resolution Scheme (DTDRS) whereby a taxpayer can resolve pending litigation on account of retrospective change in law by paying only the amount of tax as determined without the need to pay any interest or penalties on such amount. The taxpayer would have to furnish proof of withdrawal from all litigation to be able to claim closure by way of such scheme.

Further for all other asessee’s they can avail this scheme in respect of cases where an appeal is pending before the CIT(A) . Assessees looking to take benefit of this scheme shall be required to pay :

  • In case of pending appeals :
    • The disputed tax amount with interest upto date of assessment ( in cases where the disputed tax amount does not exceed Rs 1 Million)
    • The disputed tax amount with interest upto date of assessment as well as 25% of the penalty leviable ( in cases where the disputed tax amount exceeds Rs 1 Million)

While this may seem like a great way to end tax disputes, we think the scheme is fundamentally flawed as it assumes that the department is right and that the taxpayer is always wrong. Paying tax and ending litigation seems to be only a way of buying peace of mind and not a real measure to resolve practical issues that arise at the time of assessments.

Place of Effective Management provisions deferred for a year

The budget of 2016 has proposed to defer the introduction of the place of effective management (POEM) regulations by a year to 1.4.2017.

n the interim, to provide a transition mechanism for a company which is incorporated outside India and has not earlier been assessed to tax in India. The Central Government is proposed to be empowered to notify exception, modification and adaptation subject to which, the provisions of the Act relating to computation of income, treatment of unabsorbed depreciation,carry forward and set off of losses, special provision relating to avoidance of tax and the collection and recovery of taxes shall apply in a case where a foreign company is said to be resident in India due to its POEM being in India for the first time and the said company has never been resident in India before.

You may read more about the provisions of POEM in our posts here and here

Relief for REITs?

The finance minister has proposed to exempt specified domestic companies from payment of dividend distribution tax (DDT) on dividend payments to REITs whose units are required to be listed on any recognized stock exchange.

For this purpose Specified domestic companies have been defined to mean domestic companies in which the trust holds the entire value of the share capital. This exemption shall be applicable only when the dividends so paid by the company are paid out of accumulated profits and current profits after the shares have been acquired by the business trust.

More teeth for international financial services centers

To encourage the development of a financial services hub in India, the government had mooted the idea of an Internal financial services center (IFSC) in India. An IFSC being where financial services could be provided to residents and non residents in currencies other than the rupee. The first such IFSC has been notified in GIFT ( gujrat international Finance Tech-city) and this budget seems to provide the enabling regulations that can contribute to the success of GIFT and other similar IFSCs that may come up across India.

  • MAT to be applicable at only 9% on companies being units located in the for International financial services sector and deriving income solely in convertible foreign exchange. MAT on other companies is applicable at the rate of 18.5%
  • Similarly, no tax on distributed profits shall be chargeable in respect of the total income of companies as described above for any year on amounts paid by such company as dividends. the current rate for DDT on payouts by companies is 15% on gross basis.
  • No STT shall be applicable on any person on a recognized stock exchange located in International financial services centre where the consideration for such transaction is paid or payable in foreign currency. Similar exemption has also been granted to transactions in commodities by exempting them from commodities transaction tax.

It may be noted however that more incentives may be required to make Indian IFSCs a success since the tax incentives provided by other countries to similar operations far exceed those provided in India. How the industry responds to the measures will be interesting to note.

Compliance opportunity for Undisclosed Income

The finance bill proposes to introduce a one time compliance window for all persons to come forward and declare any income :

  • For which they have either not filed income tax returns or not made disclosure in their income tax returns; or
  • which has escaped assessment of tax by virtue of non-filing of income tax returns or non-disclosure of full and true material facts.

This window for declaration is open for income earned up to financial year 2015-16.

Those desirous of making a declaration under this section will be required to pay tax at 30% of the income declared along with 7.5% cess, and 7.5% penalty on the income so declared. The effective tax levy on such undisclosed income shall therefore be 45%.

As expected, persons who have already received notices subsequent to search conducted under the act, or against whom searches have been conducted, or against whom the department has received information under a tax treaty, would not be eligible to take benefit of this compliance window.

The fine details of the scheme are awaited but we are certain that in today’s times when liquidity is a real issue many businesses will be happy to declare undisclosed income to be able to legitimately infuse it into their businesses.

Deduction on bad loan provisions for NBFCs

Given the state of the banking sector and to encourage NBFC participation in such times, the budget provisions include a proposed deduction of 5% of the gross total income of NBFC’s shall be allowed on account of provision for bad and doubtful debts.

Lending a hand to home-ownership and the housing sector

The housing sector , as well as the infrastructure sector, has the capability to provide a strong booster shot to the economic growth of the country. It should therefore not be surprising that the government is keen to encourage home ownership as well as companies that can construct such homes for the bulk of the country. On this line the government has proposed the following benefits to the housing sector :

  • Additional interest deduction of INR 50,000 for loan up to 3.5 million for first time home buyers, where house cost up to 5 million
  • Deduction towards rent payment (non-HRA) under section 80GG raised to INR 60000 from INR 24000. This is expected to provide a benefit of around Rs 12,000 to eligible assessees
  • Introduction of new provision under section 80-IBA to provide for 100% deduction in profits of assessees developing projects approved by the competent authority
  • Threshold for completion of property construction for interest deduction on self- occupied property raised to 5 years from 3 years, from year of sanction of loan

Support for the Gold monetization scheme

The government has faced a rather tepid response to the gold monetization scheme that it had launched some time back to help India cut back on its appetite for gold. To make the scheme more attractive to investors the government has now proposed to provide exemption from capital gains tax to all depsit certificates issued under the scheme, interest earned from the scheme shall also be exempt from tax

Additional benefits for employment generation now available for all

To be able to reap the benefits of the demographic dividend that all us await, the country will have to generate a lot of jobs as well. To encourage such job growth the government has opened up incentives on the hiring of new employees to all eligible assessees.

Therefore all businesses who are required to get their accounts audited under section 44AB and who engage more than 100 new workers during the year whose salaries are less than or equal to Rs 25,000 per month, shall now be eligible to obtain an additional deduction of 30% of the additional wages paid to such workers . This deduction shall be allowed for three assessment years. Further, It is also proposed to provide that in the first year of a new business, 30% of all emoluments paid or payable to the employees employed during the previous year shall be allowed as deduction.

Additional Rebate for Individuals

The amount of rebate under section 87A has been increased from Rs 2000 to Rs 5000 providing an additional relief to individual tax assessees.

Deductions on Recovery of unrealized rents

A deduction of 30% is allowed to eligible assessees under the act on rental incomes in the year of receipt. On the other hand no such rebates are available on rental incomes which were unrealized in the years in which they were due but are submitted to tax upon receipt in later years.  To provide parity between taxation of rental income in the year of receipt a deduction of 30% is proposed to be allowed from unrealized rent which is recovered in subsequent years.

Taxation of Provident Funds at the time of withdrawal

To encourage pension to retain monies with pension funds the government has proposed in its budgetary provisions to tax the withdrawal in excess of 40% of the corpus of EPFs for individuals earning in excess of Rs 15,000 per month. The balance amount retained in the EPF can be used to purchase annuity instruments. Withdrawal for transfer to such annuity instruments shall not be taxed under the proposed scheme of taxation. Similarly transfer of such funds to legal heirs upon the death of the holder shall also not be subject to tax.

In a related move, the government has also proposed to increase the limit for employer contribution to recognized provident funds to Rs 150,000 from the current limit of Rs 100,000.

Rationalization of disallowance under 14A

In an effort to rationalize the disallowance made under section 14A, it has been proposed as part of the finance bill to limit such disallowance to 1% of the average monthly value of the investments that yield the exempt income that forms the subject matter of this disallowance.

The disallowance however, shall not exceed the actual expenditure claimed by the assessee under section 8D of the act.

Penalties to be reorganized

The finance bill proposes to revise penalty rates as per the following basis :

  • Penalties are proposed to levied at the rate of 50% of the tax liability in cases of under reporting of income and
  • 200% of the tax liability in cases of misreporting of facts.

Service Tax

Imposition of Krishi Kalyan Cess

The government has proposed to levy an additional cess of 0.5% in the form of Krishi Kalyan cess on all taxable services.

With the addition of this cess and the swacch bharat cess the effective rate of service tax becomes 15% ( 14%+ 0.5% +0.5%).

The cess is to be imposed from 1.6.2016

The rate seems to slowly creep towards the expected GST rates, this would mean there would not be a significant impact in terms of sticker shock at the time of introduction of the GST rates.

Right to use Spectrum to be classified as a service

The right to use radio frequency spectrum and subsequent transfers of such specturm have been classified as a declared service for the purposes of levy of service tax.
This would imply that the government would be able to recover 15% ( service tax plus cess) from transaction that include sale/purchase of such spectrum.

Additions to list of Exemptions

Exemptions have been proposed to be provided to the following services :

  • Service by way of construction, erection of original works pertaining to an airport, port (with effect from 1.3.2016)
  • Housing Under “housing for all”, Pradhan Mantri Jan Awas Yojana (with effect from 1.3.2016)
  • Construction of Low cost houses up to a carpet area of 60 square meters in a housing project under an approved housing scheme (with effect from 1.3.2016)
  • Specified services provided by IIMs (with effect from 1.3.2016)
  • Services operated by Container train operators (with effect from 1.3.2016)
  • Services of construction of canal, dam or other irrigation works  to be considered exempt from the period 1.6.2012 to 29.01.2014
  •  Transportation of passengers by stage carriage other than AC stage carriage (with effect from 1.6.2016)

Removal of Exemptions

Exemptions have been proposed to be removed from the following services :

  • Services provided by senior advocates to other advocates or to law firms (with effect from 1.4.2016)
  • Services provided by person by way of representation on arbitral tribunal to an arbitral tribunal (with effect from 1.4.2016)
  • Service by way of transport of passengers by ropeway, cable car or aerial tramway (with effect from 1.4.2016)
  • Negative List that covers services by way of transportation of goods by an aircraft or a vessel from a place outside India up to the customs station of clearance is to be omitted ( with effect from 1.6.2016)

Our Verdict

We have often argued that budgets are no longer the centerpieces of strategy that they once were. In light of the heightened expectation, the budget falls short of delivering the big bang reforms everyone seems to expect.

What has been delivered however is a strong suite of policy proposals that have the potential to provide a boost to the growth of our economy, provided they are implemented correctly.

From a practical perspective, we would have loved to see all the recommendations of the Easwar Committee find room in the budget proposals, given how tax payer friendly our tax regime would have been then. Alas, this was not the case. We still have hope as the FM has affirmed his commitment to the principles enshrined in the report.

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