EY Tax Alert. Executive summary. Key amendments to the Finance Bill, 2015 that impact the Financial Services sector. 4 May mber 2012

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1 4 May mber 2012 EY Tax Alert Key amendments to the Finance Bill, 2015 that impact the Financial Services sector Executive summary Tax Alerts cover significant tax news, developments, and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your Ernst & Young advisor The Finance Minister (FM) of India had presented the Finance Bill, 2015 (Bill) as part of the Union Budget before the Indian Parliament on 28 February The Bill contained a number of proposals to amend the Indian Tax Laws (ITL). Some of the proposals introduced in the Bill led to a number of representations being made thereon by various stakeholders. The FM then moved certain amendments to the Bill at the time of its debate before the Lok Sabha (the lower house of the Indian Parliament) and the Bill in its Revised form (Revised Bill) was passed by the Lok Sabha on 30 April The Revised Bill now lies before the Rajya Sabha (the upper house of the Indian Parliament) which would need to pass it post which, it would need to receive the assent of the President of India to become law. This alert summarizes the key amendments proposed by the FM at the time of presentation of the Bill before the Lok Sabha, which are relevant to taxpayers in the Financial Services sector.

2 Background effective management (POEM) is in India at any time in that year. The Finance Minister (FM) of India had presented the Finance Bill, 2015 (Bill) as part of the Union Budget before the Indian Parliament on 28 February The Bill contained a number of proposals to amend the Indian Tax Laws (ITL). Some of the proposals introduced in the Bill led to a number of representations being made thereon by various stakeholders. There were concerns from various stakeholders on the use of the phrase at any time as it could have an adverse impact on foreign companies where only one board meeting is held in India or even where one strategic decision was made in India. The FM proposed to delete the phrase at any time. Therefore, for the financial year onwards a foreign company is now proposed to be regarded as being resident in India if its POEM in that financial year is in India. The FM then moved certain amendments to the Bill at the time of its debate before the Lok Sabha (the lower house of the Indian Parliament) and the Bill in its Revised form (Revised Bill) was passed by the Lok Sabha on 30 April POEM continues to be defined to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made. The Revised Bill now lies before the Rajya Sabha (the upper house of the Indian Parliament) which would need to pass it post which, it would need to receive the assent of the President of India to become law. This alert summarizes the key amendments proposed by the FM at the time of presentation of the Bill before the Lok Sabha. Direct Taxes Change in test of residency for foreign companies Under the ITL, a foreign company becomes a resident of India if, during the year, its control and management is situated wholly in India. The Bill had proposed to amend this provision to provide that a foreign company will be treated as a resident of India for a financial year if its place of This is a welcome amendment. MAT - Applicability to foreign companies The Bill proposed an exclusion of capital gains (other than short-term capital gains not subject to levy of securities transaction tax) earned by Foreign Institutional Investors (FIIs) [now known as Foreign Portfolio Investors (FPIs)] on sale of Indian securities and corresponding expenditure, if any, to be added back in computing the book profit for levy of Minimum Alternate Tax (MAT). This amendment was proposed to be effective from financial year This proposal generated considerable debate as the generally understood position was that a foreign company not having a place of business in India, was not liable to pay MAT.

3 The proposals in the Bill also led to questions on applicability of MAT to incomes of FIIs arising during past years and on the interest incomes which could arise to FIIs (and are taxable at a rate lower than the MAT rate) in financial year and thereafter. Coupled with this, certain FIIs were issued draft assessment orders proposing to levy MAT for financial year and past assessments were also sought to be reopened. The proposals in the Bill where certain categories of income were sought to be excluded for computing book profit, the basis of levy of MAT, with effect from financial year , also were suffering from incongruities. With a view to clarify the tax position as applicable to foreign companies, the Revised Bill provides that, in the following cases, the specified income of (all) foreign companies will be excluded from the purview of MAT from the financial year onwards. Consequently, corresponding expenses for earning the said income are also proposed to be excluded while computing MAT. Capital gains (whether long-term or short-term) arising on transactions in securities, if such income is credited to Profit and Loss Account and tax payable on such capital gains income under normal provisions is less than the MAT rate of 18.5%. Interest, royalty or fees for technical services chargeable to tax, if such income is credited to the Profit and Loss Account and tax payable on such incomes under the normal provisions is less than the MAT rate of 18.5%. The FM also clarified in the Parliament, that assessments for past years will be concluded as per the outcome of the Indian judicial process. While the intent of the FM to provide relief to foreign companies from the levy of MAT (on a going forward basis) is evident, the language of the revised proposals may still contain some uncertainty more particularly for other incomes earned by foreign companies from India liable to tax at a rate lower than the MAT rate. Further, the basic question of applicability of MAT to foreign companies that do not have a place of business in India, appears to have been implicitly dealt with. Deferment of MAT applicability to Real Estate Investment Trust (ReIT)/ Infrastructure Investment Trust (InvIT) (Business Trust) The ITL as proposed to be amended by the Bill has a special tax regime on transfer of shares by sponsor of a Special Purpose Vehicle (SPV) to a Business Trust (ReIT) in exchange of units allotted by said trust and subsequent transfer of units of the Business Trust. While at the stage of exchange of shares against units of the Business Trust, the sponsor enjoys full exemption from capital gains under the normal provisions of the ITL, subsequent transfer of units of Business Trust will enjoy preferential tax treatment at par with tax treatment applicable to the listed securities under the ITL. Concerns were however raised by sponsor (being a company) on levy of MAT at the stage of exchange of shares against the units allotted by the Business Trust. The concern was even more valid considering that it would impact cash flow without realization of any gain to the sponsor. There was also

4 a concern of levy of MAT at the stage of the transfer of units of Business Trust. Addressing the concerns, the Revised Bill now provides for deferment of MAT applicability to the stage of transfer of units by the sponsor. The scheme proposed by the Revised Bill provides as under: There will be no levy of MAT on gains on transfer of shares of SPV to a Business Trust in exchange of units allotted by that trust. Such gain is considered by the Revised Bill to be a notional gain. Correspondingly, any notional loss incurred on transfer of shares of the SPV to a Business Trust will also be ignored for the purpose of MAT computation. There will be no levy of MAT on gain from any change in carrying amount of units in the books of sponsor as a result of restatement of values. Correspondingly, any notional loss incurred on restatement of values in the books of the sponsor shall also be ignored for the purpose of MAT computation. The actual gain on transfer of units of Business Trust, which may have been recorded in the books by reckoning the carrying value of units in books shall also be ignored for the purpose of computation. Correspondingly, any loss incurred on transfer of units of Business Trust by reckoning carrying value of units in books shall also be ignored for the purpose of MAT computation. However, there will be a MAT levy on the amount of gain, at the stage of transfer of units, such that the gain is computed on the basis of difference between the sale price of units and cost of shares of SPV (as were exchanged with the units of Business Trust) or being the difference between sale price of units and carrying amount of shares in the books of sponsor at the time of exchange of such shares against units, if such shares were carried at a value other than the cost. Similarly, the loss which is found to have been incurred by the sponsor when transfer price of units would be compared with the cost of original shares, such loss would be considered as deductible loss in the computation of book profit for levy of MAT. Global Depository Receipts (GDRs) The ITL provides for a concessional tax rate for non-residents (NRs) on income earned by way of dividends on, and by way of capital gains from transfer of, GDRs purchased in foreign currency. Further, the ITL exempts capital gains on transfer of GDR from one NR to another NR outside India, and on conversion of GDR into shares. Earlier, GDRs were governed by the Issue of Foreign Currency Convertible Bonds and Ordinary shares (through depository receipts mechanism) Scheme, 1993 (1993 Scheme). The scheme was limited to issue of Depository Receipts (DRs) based on the underlying shares or foreign currency convertible bonds of a listed Indian company. With a view to liberalize this investment avenue, the Government of India (GoI) notified a new Depository Receipts

5 Scheme, 2014 (which replaced the 1993 Scheme on GDRs). Under the new scheme, GDRs can be issued against securities of listed, unlisted or private or public companies against underlying securities. The 1993 Scheme laid down the tax treatment on GDRs, as per which, amongst others: Cost of acquisition post redemption of GDR into shares will be the price prevailing on the recognized stock exchange on the date of advice of redemption. Period of holding post redemption of GDR into shares will be reckoned from the date of advice of redemption. treatment of other GDRs has not been proposed. No business connection for fund managers in India - relaxation for certain offshore sovereign funds Under the ITL, income of an NR is taxable in India if it arises, inter alia, through a business connection in India. Presence of a fund manager in India may create a business connection/ taxable presence in India for the overseas fund and lead to income of the fund being taxable in India. Such presence may also trigger exposure of creating residency of the fund in India, on the basis of its control and management or POEM in India. However, the 2014 Scheme is silent on the tax treatment. In order to provide for the tax implications on redemption of GDR (under the new scheme) into shares of a listed company, and thereby, to consider the tax treatment prescribed in the 1993 Scheme, the ITL is proposed to be amended to provide that: The period of holding of shares will be reckoned from the date on which a request for redemption is made; and The cost of acquisition of shares will be the price of such shares prevailing on any recognised stock exchange in India on the date on which a request for redemption is made. In order to facilitate location of offshore fund managers in India, a specific regime was proposed in the Bill. The proposed regime provides that: In the case of an eligible investment fund, the fund management activity carried out through an eligible fund manager acting on behalf of such fund will not constitute business connection in India. An eligible investment fund will not be a resident in India merely because the eligible fund manager undertakes fund management activities in India. To qualify as an eligible investment fund, the following key conditions have been proposed by the Bill: The amendment is limited in its implications to redemption of GDRs issued by listed companies. The tax The fund should not be a person resident in India and should be a

6 resident of a country with whom India has entered into a DTAA; Participation/ investment by person resident in India (directly or indirectly) in the fund should not exceed 5% of the corpus of the fund; There should be minimum 25 members, who, directly or indirectly, are not connected persons; No member of the fund along with connected persons should have participation interest, directly or indirectly, of more than 10% in the fund; Aggregate participation interest of 10 or less members (directly or indirectly) along with their connected persons in the fund should be less than 50%; Investment by the fund in an entity should not exceed 20% of the corpus of the fund; The fund shall not make investment in an associate entity; Monthly average of the corpus of the fund should not be less than INR 1 billion; The fund shall not carry on or control and manage (directly or indirectly) any business in India or from India; and The remuneration paid by the fund to an eligible fund manager in respect of any fund management activity should not be less than the arm s length price. It is proposed that of the conditions listed above, the following three conditions will not apply in case of investment funds set up by the Government of a foreign state or a sovereign fund and such other conditions as may be notified the GoI and be subject to fulfilment of conditions as may be specified. There should be minimum 25 members, who, directly or indirectly, are not connected persons; No member of the fund along with connected persons should have participation interest, directly or indirectly, of more than 10% in the fund; and Aggregate participation interest of 10 or less members (directly or indirectly) along with their connected persons in the fund should be less than 50%. Additionally, it has been provided that the special regime shall be applied in accordance with guidelines and in such manner as the Central Board of Direct Taxes may prescribe. Tax neutrality on consolidation of similar schemes of mutual funds The Securities and Exchange Board of India (SEBI) has been encouraging mutual funds to consolidate different schemes having similar features with a view to have simple and fewer number of schemes. However, such consolidation presently results in capital gains tax payable by unit holders. The Bill proposed to exempt the transfer of units in the hands of the unit holders upon consolidation of schemes, provided they are allotted units in the consolidated scheme of the mutual fund. The Bill proposed to restrict the exemption to only cases of consolidation of two or more schemes of an equity oriented mutual fund or two or more schemes of a non-equity oriented mutual fund.

7 Further, it was proposed that the cost of acquisition and the period of holding of the units held by unit holders in the consolidated scheme shall, respectively, be the cost of acquisition and the period of holding in the consolidating scheme. It is now further proposed that while computing the capital gains on subsequent sale of units in the consolidated scheme, the period for which the units were held in the consolidating scheme shall be included. Amendments to align ITL with ICDS The GoI notified Income Computation and Disclosure Standards (ICDS) on 31 March 2015, effective from financial year onwards, to be complied by all taxpayers following mercantile method of accounting while computing income under the heads Profits and Gains of business or profession or Income from other sources 2. Certain provisions of ICDS did not align with provisions of the ITL. Hence, the Revised Bill proposes to modify some provisions of ITL as follows: Borrowing costs: ICDS IX provides for capitalisation of borrowing costs in respect of qualifying assets viz tangible/ intangible assets and inventories 3. The ITL provides deduction in respect of all borrowing costs except when they are incurred for acquisition of 2 Refer EY Tax Alert dated 2 April 2015 Indian Government notifies 10 Income Computation and Disclosure Standards effective from financial year onwards. 3 But only those inventories that require period of 12 months or more to bring them to saleable condition an asset for extension of existing business or profession. The condition of acquisition of asset for extension of existing business or profession for disallowance of borrowing costs under the ITL resulted in disharmony with ICDS since ICDS does not have this condition. The Revised Bill proposes to omit the condition of asset acquisition for extension of existing business or profession for disallowance of borrowing cost to align the ITL with ICDS. Revenue recognition: There is an apprehension that application of some ICDS like Revenue Recognition or Provisions, Contingent Liabilities and Contingent assets may result in accelerated recognition of income for tax purposes though the same may not be recorded in books of account as per applicable GAAP. It is possible that such income may eventually be found to be irrecoverable. While the ITL provides for a deduction for bad debts which are written off as irrecoverable in taxpayer s accounts, it would be difficult for taxpayers to claim a deduction (bad debts) for income which is irrecoverable but hitherto not recognized in the books. The Revised Bill provides that such debt taxed as per ICDS but not recognized in the books shall be allowed as bad debt in the financial year in which it becomes irrecoverable and it shall be deemed as if such debt has been written off as irrecoverable in the accounts for this purpose.

8 Indirect taxes Amendment to the provisions of Section 76 relating to penalty for failure to pay Service tax As per the earlier proposed Section 76(2), where the amount of Service tax as payable under Section 73(2) is modified by Commissioner (Appeals) or Appellate Tribunal or by the Court, the amount of penalty payable thereon will also be modified. The benefit of reduced penalty (equal to 25% of the penalty imposed) would be available if Service tax along with interest and such reduced penalty is paid within 30 days from the date of the receipt of the order modifying the amount of Service tax. This has now been substituted to provide that where the amount of penalty is increased by Commissioner (Appeals) or Appellate Tribunal or by the Court, over and above the amount as determined under Section 73(2), the time within which the reduced penalty (equal to 25% of the penalty imposed) is payable under proviso to Section 76(1) shall be counted from the date of such order. As per Clause (ii) of the proviso to Section 76(1), the benefit of reduced penalty is available if Service tax, interest and such reduced penalty is paid within 30 days from the date of the order determining the Service tax amount under Section 73(2). Amendment has been further made to provide that where the Service tax and interest is paid within 30 days of the date of service of show cause notice (SCN), no penalty shall be payable and proceedings in respect of such Service tax and interest shall be deemed to have been concluded. This amendment is in line with provisions under Central Excise and Customs. Amendment to the provisions of Section 78 relating to penalty for suppression etc., of value of taxable services A new proviso has been added to Section 78(1) which has the effect of reducing the penalty in cases where the details relating to transactions falling under section 78(1), are recorded in specified records for the period beginning from 8 April 2011 up to the date on which the Bill is enacted. The penalty in respect of such transactions shall be 50% of the amount of Service tax determined. Specified records has been defined by way of an explanation to mean records including computerized data as are required to be maintained by an taxpayer or invoices recorded by the taxpayer in the books of accounts. As per the earlier proposal, where the Service tax and interest is paid within a period of thirty days of the date of service of notice under Section 73(1), the penalty payable shall be 15% of service tax. It has now been amended to include that where such penalty of 15% is paid, the proceedings in respect of the Service tax, interest and penalty shall be deemed to be concluded. The provision of section 78(2) relating to penalty on modified amount of Service tax has been substituted. As per the substituted provisions, where the amount of Service tax is modified, the amount of penalty and interest shall also be modified accordingly.

9 Where the amount of Service tax or penalty is increased by the Commissioner (Appeals)/ Appellate Tribunal/ Court, over and above the amount determined under Section 73(2), the time within which the interest and reduced penalty is payable shall be counted from the date of such order. This is in line with substituted Section 76(2) as aforesaid. Comments Some of the amendments made to the provisions of the Bill will be welcomed by taxpayers since they are made pursuant to representations made by the stakeholders on the provisions of the Bill as introduced in the Indian Parliament on 28 February Amendment in the transitory provisions Section 78B(2), which earlier proposed transitory provisions for levy of penalty in respect of cases falling under Section 73(4A), has been substituted. Section 73(4A) covered cases where during the course of audit, investigation etc., Service tax was found to be not levied or not paid or short levied or short paid, and the details of the transactions are available in the specified records. Section 73(4A) has been already omitted in the Union Budget From a direct tax perspective, amendment to definition of POEM comes as a huge relief. However, some amendments dealing with MAT on foreign companies, applicability of MAT to incomes arising to FIIs in past years or interest incomes arising in financial year or thereafter (if taxable at a rate lower than the MAT rate), alignment with ICDS, etc. may raise fresh concerns for taxpayers with potential for litigation. The concerns of stakeholders on interpretation of provisions dealing with indirect transfer remain unaddressed. The substituted Section 78B(2) specifies that where SCN has been issued, but no order has been passed before the date on which the Bill is enacted, the period of 30 days for the closure of proceedings (under Section 76 and Section 78) shall be counted from the date on which the Bill is enacted.

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