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Budget 2014: Impact On Tax Policy?

Published on Fri, Jul 11,2014 | 18:46, Updated at Mon, Jul 14 at 21:27Source : CNBC-TV18 |   Watch Video :

Doshi: Hello and welcome to this special discussion on Budget and taxes as we try and ascertain the impact on tax policy and therefore the impact on corporate India. I have with me today Dinesh Kanabar Deputy CEO, KPMG, Daksha Baxi Executive Director, Khaitan & Co and Sanjay Tolia Partner, PwC India to take you through some of the most important pronouncements in this very first Budget presented by the Modi government.

I want to start by asking you the question firstly on the faith that the finance minister has put on being able to achieve the tax revenue target, a growth of 19.7 percent, Mr. Kanabar, do you think that this is doable, feasible or a bit of leap of faith there?

Kanabar: One of the things which has always bothered us is the entire aggression of the tax office is driven by the revenue targets and when the finance minister without any possibility of talking about how he is really going to increase the economy and therefore the revenue share, talks about being able to collect 20 percent more then I am only fearing that are we going to see some more litigation on the Shell route really and that is a very worrying thought.

Doshi: Daksha, Have we put retrospective amendments behind us, have we finally with this new government said good bye to retrospective amendments are there any in this Budget?

Baxi: Well in the first place I don’t think we have dealt with the retrospective amendments at all.

Doshi: Of the past forget that I will get to that later, I am saying but this Budget does it have any retrospective amendments?

Baxi: If you are you talking in principles actually it does, because in case of mutual funds, where the non-equity oriented mutual funds there has been a change in the capital gains tax rate from 10 to 20 percent and also the holding period for long term capital gains to be treated as long term capital asset. It’s happening from April 1st we are already in July, its three months but principally speaking there is retrospective change.

Doshi: Sanjay, Do you disagree with either of those answers and either of those questions?

Tolia: If I have to talk about transfer pricing there is a deemed international transaction definition and we have Kodak ruling in Mumbai and they have tried to overrule that by making an amendment, but that amendment is from assessment year 2015-2016, it is prospective.

Doshi: I am going to take up retroactive taxation from the past and the baggage of that later on in the show, the first thing I want to come up with is some positive things he said with regards with advance rulings, he said residents can now avail of advance rulings within certain specified thresholds, more Authority for Advance Ruling (AAR) benches and he also spoke broadly of a revival of the settlement commission and strengthening that process, what do you make of that impact?

Kanabar: First let me make a point at what is the finance minister expected to do. He is supposed to talk about how is he going to reduce litigation and address litigation in the biggest space that exists today. So he has given both of those, the biggest space where the litigation exists today is transfer pricing and we will talk a little bit later about it and then he has come back to say that I am putting up the mechanism of authority for advance ruling on a different pedestal altogether than what exists today. I will allow residents to take advantage of authority for advance ruling and I will constitute multiple benches. If you know an answer in advance then you are so much better off in knowing exactly where you stand. Therefore you are trying to kill litigation so to say coming in future. So it is a very positive thing, in fact I would commend the finance minister for that. My only concern is that today we have one bench with no chairman for years on end, the six months mandatory time limit actually being extended to two to three years. So, are we really going to man all those benches, are we going to make the six month thing mandatory, if the implementation happens right a very laudable thing from my perspective.

Doshi: Daksha, I assume you agree broadly with that unless you have something different to say or I will move on to the next one which is the issue on REITS. That has been applauded by the stock markets as well today, especially in real estate stocks – the tax pass through status for REITS and for infrastructure trusts as well.

Baxi: That is a very laudable provision that has been brought in and it will pave the way for the REITS and the infrastructure investment funds regime to be implemented which the SEBI has not yet ruled out. One of the reasons has been that there is not tax clarity.

Doshi: Is there anything else missing in terms of tax treatment on REITS? Any parts of the piece that are still missing? I think there still are missing pieces to this which don’t allow for the perfect situation.

Baxi: There are a couple of pieces, there is a little bit of a complication and one piece which I would have thought would have been easier or better, one is, when the sponsor transfers the asset or the shares of the company which owns the real estate into the SPV his capital gains tax is deferred, it would have been better if the provision was similar to the one that we have for real estate where the real estate is converted into stock and trade. The capital gained as of that date, as per the market value of that date is ascertained. Only thing is that it is payable at the time when the stock is sold. Whereas in this case what has happened is that it is just said that his unit will have a holding period from the time that he held the earlier asset and he will not get the benefit that other unit holders get for the capital gains tax being on the stock market either exempt or at 15 percent but he will have a 20 percent capital gains tax and that also he will have to hold also for 36 months.

Doshi: Does this kill the viability of REITS and Infrastructure Trusts?

Kanabar: I think you ask a question, is the entire framework today ready? The answer probably is no. There are number of other things which need to happen. Take stamp duty as an example. Unless we have an amendment to stamp duty laws this is not going to work at all. This is what could have been done in the Budget and he couldn’t have done anything on the stamp duty in the Budget but for REITS to be effective there are a variety of things on FEMA, on stamp duty, all of those need to fall in place before we can roll it out.

Doshi: Including on tax as Daksha just pointed out.

Kanabar: Absolutely.

Doshi: So, we only have half the glass full on tax when it comes to REITS as yet. We still need to go another couple of steps before this becomes viable in any fashion. I want to come to the capital gains taxation changes. There is a change that impacts both the sale of unlisted shares as well as certain mutual fund units. Mr Kanabar can you talk us through what this means and the impact areas of this?

Kanabar: The first change is that the shares being a long term capital gain if its being held for more than 12 months which today applies to all shares is now restricted only to listed shares. So, all unlisted shares be it public company, be it private company need to be held for a period of 36 months in order to qualify for long term capital gains. The same thing applies equally for units.

Doshi: All mutual fund units or debt units only?

Kanabar: Debt units. Equity oriented units if they are listed it goes on for a period of 12 months.

Doshi: The rates of long term capital gains tax have been doubled both for unlisted shares as well as mutual fund debt units?

Kanbar: That’s right.

Doshi: The mutual fund industry is looking at this very negatively as the death of FMPs so to speak. What does this mean from a transaction of unlisted shares point of view as well as for the mutual fund debt segment?

Baxi: From the perspective of transaction of unlisted shares we know that majority of the private equity investments are also made in more like VCU companies which are unlisted companies. If the private equity investors do not get the treaty benefit then if the shares are held for less than 36 months …… (Interrupted)

Doshi: Usually that doesn’t happen with PE or VC right?

Baxi:  It doesn’t happen but there could be situations, even reorganisation can result in transfer of shares. So, that would create a lot of uncertainty.

Doshi: If they hold it for less than 36 months they pay short term capital gains tax and even the long term capital gains tax has doubled from 10-20 percent, right?

Baxi: Yes.

Doshi: Those are the impact areas for capital gains tax.

Kanabar: The positive part is FIIs holding is now clarified in law to be capital asset and therefore resulting in a capital gain.

Doshi: Dividend tax two changes again that I was able to identify, one, the concessional rate of 15 percent on dividend earned from foreign subsidiaries has now been extended indefinitely as he seemed to say. However there is a change on dividend tax in terms of grossing out. Daksha if you could explain what really that means and what is the impact either on the company that is paying the dividend or if the impact is on the recipient of the dividend?

Baxi: If the company was paying Rs 100 as a dividend which is what the shareholder is supposed to have received under the current manner of computing dividend distribution tax, the companies cost would have been Rs 117 and the DDT would have been 15 percent plus surcharge plus cess. So, it would have come to Rs 17. Now if the shareholder has to receive Rs 100 the company will have to dish out Rs 120.48.

Doshi: Why is that?

Baxi: Because now the 15 percent that needs to be computed for the purposes of paying Rs 100 has to be grossed up. So, Rs 100 has to be added to Rs 15 and then 15 percent has to be worked out on that.

Doshi: This is a step back in time or a step ahead?

Kanabar: It is just an incremental revenue gathering exercise. It makes no sense at all.

Doshi: Is it going to amount to too much money?

Baxi: 2.47 percent increase.

Kanabar: It actually amounts to a lot of money. You take a listed company, a Unilever, Colgate or whatever else are going to declare a particular amount of dividend which is going to go to shareholders and they expect it year on year, now the tax on it itself has to be grossed up in computing the tax liability. So, you are just looking at tax on tax nothing else other than that. So, it is deemed that the tax is paid on behalf of the shareholder and therefore you pay tax on that also.

Doshi: If DDT was discouraging companies from paying dividends this a further discouragement if I have understood that correctly?

Kanabar: That’s right.

Doshi: I want to come to the FII bit. You have already made one mention of settling the contentious issue of whether proceeds of sale of shares for FIIs amounts to business income or capital gains and the finance minister said very clearly it is capital gains. There is also some bit about fund managers now being able to relocate to India if they wanted to and not being treated as permanent establishments, what do you make of that?

Kanabar: Basically the entire representation which was being made the finance ministry was to say that there is this uncertainty as to whether the income which arises to an FII is business income or capital gains. Given that uncertainty if there were managers sitting out of India they would constitute a permanent establishment in which case the gain would be attributable to the permanent establishment and taxable in India.

So, the change in law is very simple. It just says merely that any asset held by an FII will be deemed to be a capital asset and therefore gain arising as capital gain. The consequence which the finance minister spoke to in his speech really was that as a result of which if there is somebody out here who constitutes a permanent establishment it is not consequential because the gain is a capital gain and not a business income.

Doshi: I was treating this as two separate things which is that from what I understood and remembered a bunch of litigations on whether this is business income or capital gains that FIIs were fighting anyways and therefore there is a big relief on that front and that this whole relocation of fund managers in India and therefore a permanent establishment not being attributed to them …. (Interrupted)

Kanabar: I am closely involved with the subject so I can say with a degree of authority. There was hardly any FII in the recent times which ever took a position that its income was business income.

Doshi: I thought the tax department took that position.

Kanabar: No. Tax department uniformly accepted the position that income arising to an FII is business income. It is really the FIIs who tried to say that their income was business income and because they had no permanent establishment there was no tax at all. Then there were rulings from AAR etc, much of that was buried over the last few years and the practical position on the ground was that both sides accepted it was capital gains. What was giving rise to this uncertainty was that if there were managers in India and they were held to be constituting a permanent establishment would the tax office rake up the issue that this is business income and that is sought to be covered by this amendment.

Doshi: Daksha you want to add to that? Big relief for FIIs or minor relief for FIIs

Baxi: To my mind it is still a minor relief. Something more needed to be added for clarifying why the presence of fund managers would not constitute permanent establishment because that is still not clarified.

Doshi: So, you are saying it is only half done as yet not fully done?

Baxi: Yes.

Doshi: Investment allowances extended to 2017 and also expanded now to include SME capital outlay of Rs 25 crores and more. This is a 2013 thing that Mr. Chidambaram had introduced. I don’t know how far it has gone in being able to boost capital expenditure or kickstart the investment cycle. I suppose it is a minor measure to help?

Kanabar: It is actually a signalling to say that India wants to support manufacturing. If I look at two amendments which have been made, one is the investment allowance of 15 percent other is the extension of 80-IA by a period of three years for the power sector and then inclusion of certain further activities as a part of what constitutes power infrastructure. We thought almost that for all practical purposes the days of allowances and deductions were over, the fact that these are being continued just shows that the government is wanting to give a thrust to these two sectors.

Doshi: So, manufacturing, power, focus on jobs etc, but small measure right? Does it go a long way when companies plan whether to invest or not are these important contributing factors?        

Kanabar: They do contribute. I don’t think the decision is made solely on that basis but they do help in taking the right decision.  

Doshi: I come to transfer pricing now. A bunch of changes there, some of it sounds like gobbledygook right? The move to an inter-quartile range, the rollback of APA, you want to explain to us what this means and what the impact on companies will be?

Tolia: It is a very welcome move because the biggest litigation in the country today is transfer pricing. Let me take the APA first. From the APAs standpoint I can talk about three good things which have happened. One, we have around 400 applications as of today and we just have 5 APAs which are signed. The move of expanding the APA team to expedite these disposals is a good thing. Two, to take it as a rollback. Look at the APA, the APA actually works for five years so you can get a prospective five year APA. What rollback means is that you can apply the same principles…. (Interrupted)

Doshi: So the terms agreed upon in the APA can be applied to previous transactions?

Tolia: The terms agreed upon in the APA can be applied to previous four years transaction.

Doshi: What if those four years were being litigated then what would you do?

Tolia: If you look at the situation today 2011 is the audit which is going to start now. Some of the APAs which will get signed later probably will cover some of these years. So obviously they will have some principles which will be laid down in the APA application itself in the APA agreement actually. The law says that the APA agreement will provide the principles which will be applied for the rollback provisions. One of the provision which probably needs to be amended is that if the assessment is completed and then the APA is signed because APA could take some time to sign then how would that apply to the past years. That is something which probably the rules will have to come …. (Interrupted)

Doshi: More guidance from that.

Tolia: Yeah.

Doshi: Inter-quartile range?

Tolia: One of the only country which I know which has this arithmetic mean concept is India and the global best practice is to apply range, so you take comparables, you apply a range and if you fit in the range you are at arms length and this arithmetic mean had created a lot of challenges.

Doshi: Because it expected your margins to be very close or exactly same as a competitors margins which was unrealistic so to speak, right?

Tolia: Correct.

Doshi: So, now you have a range to work with if I was to put it in the simplest possible English?

Tolia: If you have a range, you get covered; you would not have a challenge. If you look at the new Companies Act and the Clause 49 which is asking for related party transactions to be arms length, if you look at those principles, the arms length is not defined in those provisions. If you look at arms length, arms length is much broader than a mean. So, I would think that this particular change in the Income Tax Act coincides with these two changes which have happened and the range concept actually goes a way to explain what is arms length and not what is an arms length price.

Doshi: These are two key things in transfer pricing or is there anything else you want to touch upon?

Tolia: One of the other things which was relevant for us was that typically when you look at comparables, you use a multiple year data because you want to look at evening out business cycles; you can't be same for the same year. The law was not very clear in terms of using multiple year data, it was quite restrictive; I think they have relaxed it which is good.

Doshi: So this perfectly segues into what they haven't done because what they didn't do was deal with matters like Shell case and we are calling it the Shell problem. There was some expectation from within the tax fraternity in the last few weeks when I have been speaking to them saying, look I hope you put some guidance out because this is otherwise endless litigation. He didn't do anything on that; a big miss in your books?

Tolia: It is a big miss…

Doshi: What could he have done though because these are already being litigated upon; these cases, whether it is Vodafone or Shell, all of them?

Tolia: There is no clarity around whether issue of shares could ever become taxable transactions.

Doshi: According to them it is taxable. That is the position of the tax department. What could the FM have done to offer you any relief on this front? Specifically what could he have said in the Budget, I get all the context of foreign investment and all that?

Tolia: What he could have done is, he could have said that issue of shares is outside the transfer pricing regime. That is as simple as it is. If he wanted investments in India he could have made it very simple that issue of shares should be outside the transactions.

Kanabar: Actually I don't agree with it. Section 92 which is the transfer pricing main charging section goes back to say that any income arising in an international transaction would be computed at arm's length price. Therefore for a transaction to be an international transaction and therefore susceptible to transfer pricing you need income to be arising. In a share infusion there is no income arising, because whatever is that premium really goes to a premium account. There is no income arising to a company. That is all that he had to clarify.

Doshi: So he could have done it. So, you would count it as a big miss?

Kanabar: Absolutely. I would say if there are three big misses this is one of them.

Doshi: The second one is GAAR?

Kanabar: The second I would say is GAAR?

Doshi: No word on GAAR. However that doesn't mean that it has not been deferred?

Kanabar: Unless we hear something in the next Budget which keeps it back, it is implemented because the law is very clear.

Doshi: Maybe he left it for the next Budget? You are not hopeful?

Kanabar: It is not a question that I am not hopeful; I certainly hope that there will be representations on the subject and he will hear it but I really wish he had kept it back.

Doshi: What is your third miss, is it MAT or is it something else?

Kanabar: I would actually say that the third miss is Section 9 amendment. There was a Shome Committee report…today we have an issue where international transactions are getting impacted because of value residing in India and there is this whole issue of interpretation of what constitutes substantial value of assets in India, etc. It is a plethora of things.

Doshi: You are referring to the retroactive amendment that took place a few years ago which is now being referred to publicly as the Vodafone case; that's Section 9.

Kanabar: I am not referring to retrospectivity, I am only referring to the amendment as it is. So, assuming that the section applies today prospectively even then there are issues around that section. More important, the government constituted a committee, Shome Committee - they gave extensive recommendations on what needs to happen and I can assure you these challenges are very significant; they are not small.

Doshi: So, you wanted what, a clarity on what is substantial?

Kanabar: Number of things. For example the way the section is worded, it says that a foreign company with a subsidiary in India with underlying value of assets which are substantial will be deemed to be a company in India. Therefore if that foreign company was to declare a dividend that dividend would be a dividend taxable in India. I am just giving you one example, there are twenty such things. What happens in the case of listed companies? There are several listed companies where trade is happening every single day and theoretically nobody is paying taxes and they are violating Indian law. What happens to de minimis transfers, are they covered not covered? All of this was covered by the Shome committee report. That report had to be accepted and simply put into law.

Doshi: MAT was a big miss as well. That was high on everybody's expectation list but may be it was just revenue he couldn’t give away. I do want to talk about the biggest miss of them all which was the expectation that he would reverse the retroactive amendments made in the Budget two years ago by Pranab Mukherjee which he has not done. He has simply said that cases arising from just that one retroactive amendment to Section 9 not the others, not royalties etc, just those cases will be referred to a high level CBDT committee. What is that committee going to do? Will it have any powers to settle any of these matters or has he just kept the hope cycle going and really nothing else?

Baxi: If he really means that there is something really coming out of it then he should give the authority to the committee.

Doshi: The CBDT committee doesn’t have authority.

Kanabar: He has referred that the committee will deal with new cases not the cases which are already there…that’s the way I interpreted it. So, almost all the matters till today are already there in litigation. What he is talking about is if there are some cases which have not yet caught the attention of the tax office before we initiate action it will go to this committee. The committee can only implement the law. What authority can you give to the committee?

Baxi: The committee could perhaps look at it and say what constitutes substantial value, it does not constitute substantial value, etc. So, they could perhaps go into all of those aspects and say this is the kind of transaction which cannot be covered. The point is that there is no clarity. What will the committee clarify on? It will only simply read the law and try and apply it.          

Doshi: That was probably the biggest miss in terms of expectations of the tax fraternity, corporate India and foreign investors.For those of you who are citizens and not corporate citizens there are some benefits in this tax policy including hike in the exemption limit, a hike in the investment deduction and a hike in the deduction for housing loan interest rates. So, all of that is good news for you. 

 
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