India Tax Alert. Revised Direct Taxes Code bill tabled in Parliament. Corporate tax rate. 5 September 2010

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1 International Tax India Tax Alert 5 September 2010 Revised Direct Taxes Code bill tabled in Parliament Contacts K.R. Sekar krsekar@deloitte.com Vipul Jhaveri vjhaveri@deloitte.com The Indian Finance Minister presented the Direct Taxes Code Bill, 2010 to the Lower House of Parliament on 30 August The revised proposed Code builds on a 2009 draft and two related discussion papers. The key changes in the revised draft are that the effective date of the new Direct Taxes Code would be deferred one year to 1 April 2012 and the tax treaty override provision would be eliminated. Other salient proposed changes that affect companies are highlighted below. The Direct Taxes Code and the original discussion paper, unveiled on 12 August 2009 to replace the current Income Taxes Act (ITA) that dates from 1961, propose to bring about significant structural changes to direct taxation in India. The code will consolidate the law relating to all direct taxes and create a system that facilitates voluntary compliance, with the ultimate goals of improving the efficiency and equity of the Indian tax system. The revised discussion paper issued in June 2010 responded to a variety of comments and concerns of the business community and other stakeholders about certain proposed provisions. The August bill can be considered an amalgam of the provisions in the Income Tax Act, 1961 and those in the 2009 draft and discussion papers; some provisions that were not in the original draft have found their place in the revised Bill. Corporate tax rate The corporate income tax rate for all companies would be 30% (inclusive of the surcharge and cess), as compared to the 25% provided in the 2009 draft code. The upward revision in the tax rate was presaged in the June discussion paper. Domestic companies currently pay a 7.5% surcharge where total income exceeds INR 10 million and a 3% education cess in addition to the 30% tax and foreign companies are subject to a rate of 40%. Foreign companies that have a branch in India would be subject to an additional branch profits tax of 15%.

2 Losses would be allowed to be carried forward indefinitely (currently eight years). Dividend Distribution Tax The rate of the dividend distribution tax would be a flat 15%; the cess and surcharge would be eliminated (currently, domestic companies pay dividend distribution tax of %, which includes the surcharge and education cess). Mutual funds and life insurers would be subject to a 5% dividend distribution tax on income they distribute, although income received by the investor would be exempt from tax. Special economic zone (SEZ) developers and SEZ units would be brought within the scope of the tax. Minimum Alternate Tax The proposed changes to Minimum Alternate Tax (MAT) have been scaled back. The first Draft Taxes Code proposed that MAT would be imposed at a rate of 2% of gross assets (0.25% for banks) After taking comments into account, the government has decided to continue to impose MAT on profits rather than assets. However, the rate would be increased from 18% to 20%, the carryforward period would be extended from 10 to 15 years and a MAT credit would be granted for 15 years. Residence A company would be deemed to be resident in India if it is an Indian company or if the company s place of effective management is in India. The place of effective management for these purposes is defined to mean: The place where the board of directors or executive directors of the company make their decisions; or The place where the executive directors or officers of the company perform their functions and the board of directors routinely approves the commercial and strategic decisions taken by the executive directors or officers. In all cases (other than in the case of an individual), a person would be deemed to be resident in India if the management and control of its affairs are situated, in whole or in part, in India at any time during the financial year. Foreign tax credit A resident would be entitled to a unilateral credit for income tax paid in a foreign country. Where the income is derived from a country that has concluded a tax treaty with India, the credit would be allowed to offset Indian income tax in accordance with the treaty provisions. If there is no treaty and the applicable tax rates in India and the foreign country

3 are different, the lower rate would apply, and if the rates are the same, the Indian tax rate would apply. The foreign tax credit could not exceed the tax payable under the Direct Taxes Code and the central government would be authorized to prescribe the method for computing the amount of the credit and the manner for claiming the credit. Reorganizations Business reorganizations involving a nonresident would not be taxexempt unless certain conditions are satisfied. Accordingly, crossborder mergers and demergers would have tax implications. In the case of an amalgamation or demerger of foreign companies, 75% of the shareholders would have to continue to hold shares in the amalgamated/resulting company to benefit from the capital gains tax exemption (currently only a 25% holding is required). Anti-avoidance General anti-avoidance rule: The features of the originally proposed GAAR have been retained. The GAAR would apply where the main purpose of an arrangement (whether domestic or cross-border) is to obtain a tax benefit and the arrangement (1) has been entered into or carried out in a manner not normally used for bona fide business purposes; (2) has created rights and obligations that normally would not be created between persons dealing at arm's length; or (3) results, directly or indirectly, in the misuse or abuse of the Indian tax code or lacks commercial substance. An arrangement would be presumed to be entered into for purposes of obtaining a tax benefit if it results in a reduction in the tax base and/or increases tax losses. The taxpayer would be required to demonstrate that obtaining a tax benefit was not the main purpose of the arrangement. If an anti-avoidance arrangement is found to exist, the tax authorities would be empowered to disregard the transaction and determine the tax consequences of the taxpayer as if the arrangement had not been entered. In accordance with the revised discussion paper issued in June 2010, the GAAR would apply in accordance with guidelines as may be prescribed by the central government and a Dispute Resolution Panel would be available where GAAR provisions are invoked. The GAAR would prevail over any tax treaty provisions. Controlled foreign companies (CFC): As indicated in the revised discussion paper, the Draft Taxes Code introduces the concept the taxation of CFC income. Under the CFC provisions, passive income earned by a foreign company controlled directly or indirectly by a resident in India would be taxed in the hands of the Indian company as a deemed dividend. A foreign company would be considered a CFC if the following conditions are satisfied:

4 It is resident in a country or territory that imposes a lower rate of tax and the amount of tax paid in that country/territory in respect of profits is less than 50% of the corresponding tax payable on such profits computed under the Indian Direct Taxes Code; The shares of the foreign company are not traded on any stock exchange recognized by the law of the jurisdiction in which it is resident; One or more persons individually or collectively exercise control over the company through specified percentages by way of the ownership of shares, or over assets or income, or exercise a dominant influence, or exert a decisive influence at the shareholders meeting; It is not engaged in an active trade or business and 50% or more of its income is passive income, such as dividends, interest, royalties, capital gains, income from the sale or licensing of intangible property, income from the sale of goods or the provision of services to related parties, income from management, holding or investments in financial assets, etc; The relevant profits exceed INR 2.5 million. The CFC rules would override the provisions of a tax treaty. Tax treaties The later in time doctrine that appeared in the original draft of the Direct Taxes Code has been scrapped. It is now proposed that the existing provisions under the Income Taxes Act 1961ITA, under which the domestic law or the relevant tax treaty, whichever is more beneficial to the taxpayer, be retained. However, as noted above, if the GAAR, the CFC rules or the branch profits tax applies, those rules would prevail over the provisions of a tax treaty. It also has been proposed that a recipient of income would be entitled to claim benefits under a specific treaty by producing a residence certificate (in a prescribed format) issued by the tax authorities of the country in which the income recipient is resident. Presumptive taxation It has been proposed that income from specified businesses be determined on a presumptive basis. In such cases, taxable income from a business carried out by a foreign company or nonresident would be based on a percentage of the amounts due or received, as follows: 14% of gross receipts of a nonresident providing services or facilities in connection with prospecting for, or the extraction or production of, mineral oil or natural gas; or for the supply of plant and machinery on hire, used or to be used, in prospecting for, or the extraction or production of, mineral oils or natural gas;

5 10% of gross receipts of a foreign company where income is derived from civil construction relating to an approved turnkey power project; and 10% and 7% of gross receipts of a nonresident deriving income from the operation of ships and aircraft. Comments The proposed bill has been presented to the Lower House of Parliament for discussion and approval and it is likely that the bill may be referred to a House Finance Committee for consideration and input before being presented to the Upper House. The government also could consider any proposed recommendations/changes made by other Ministries, Chambers, professional bodies, etc. It is likely that the bill will become effective on 1 April In the interim, companies and other assesses should examine and understand any provisions that could impact their operations and plan for any changes that may be needed. Security Legal Privacy Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanning multiple industries. With a globally connected network of member firms in more than 140 countries, Deloitte brings world-class capabilities and deep local expertise to help clients succeed wherever they operate. Deloitte's approximately 169,000 professionals are committed to becoming the standard of excellence. This publication contains general information only, and none of Deloitte Touche Tohmatsu Limited, Deloitte Global Services Limited, Deloitte Global Services Holdings Limited, the Deloitte Touche Tohmatsu Verein, any of their member firms, or any of the foregoing s affiliates (collectively the Deloitte Network ) are, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your finances or your business. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person who relies on this publication Deloitte Global Services Limited