India Budget 2021-2022: All roads lead to India

This article discusses the noteworthy direct tax proposals of the Bill relevant to the international business community – as investors in India as well as offshore businesses an Indian nexus. While the proposals vis-à-vis foreign investors are largely positive and a welcome move, proposals vis-à-vis offshore businesses with sales to India-based customers (either as B2B or B2C) may be an area of concern.

India’s 2% equalisation levy – expanding a ‘digital tax’ to brick & mortar businesses?

In order to bring the income of offshore digital businesses within India’s tax net, India had introduced the 2% equalisation levy (2% EL) with effect from 1 April 2020.

The 2% EL is chargeable on consideration receivable by a non-resident “e-commerce operator” for “e-commerce supply or services” provided or facilitated by it on or after April 1, 2020 (subject to satisfaction of certain conditions). The international business community had been requesting for clarifications on various aspects of 2% EL provisions.

An important industry-wide issue was the lack of clarity on whether e-commerce supply or services provided by non-residents up to 31 March 2021, and taxable in India as royalty or fees for technical services, were also taxable under the 2% EL provisions. The Bill has clarified that 2% EL is not applicable in case of e-commerce supply or services taxable in India as royalty or fees for technical services in India. This welcome clarification is effective retrospectively from 1 April 2020 and applies with effect from Financial Year (FY) 2020-21.

However, the Bill has also proposed two more amendments to the 2% EL provisions, which may not go down very well with the industry, especially given the retrospective nature of these two amendments (as they have been made applicable from 1 April 2020).

The first amendment deals with an interpretational issue typically faced by e-commerce facilitators such as online marketplaces. The issue was whether the 2% EL would be levied on the entire value of goods / services sold over the marketplace platform (say USD 100), or whether it would be levied only on the commission component retained by the marketplace (say USD 1). The Bill clarifies that 2% EL is to be levied on the entire value of goods / services sold by an e-commerce operator (ie USD 100), irrespective of whether the e-commerce operator (such as an e-commerce marketplace) is the owner of goods / provider of services.

In the second amendment that may have far-reaching consequences, the Bill proposes to widen the ambit of the 2% EL by inserting a clarification to the definition of “e-commerce supply or services”. Under the 2% EL provisions as they stand presently, “e-commerce supply or services” is defined to mean the online sale of goods or online provision of services (including facilitation of the sale of such goods or services) by an e-commerce operator. The Bill proposes to clarify that “online sale of goods” and “online provision of services” will include any of the following online activities:

(a) acceptance of offer for sale;

(b) placing or acceptance of purchase order;

(d) payment of consideration; or

(e) supply of goods or provision of services, partly or wholly.

The above amendment would imply that as long as any the above activities is conducted online between an offshore business and Indian customer, the transaction may be subject to 2% EL even if the actual sale of goods or provision of services is conducted offline. For instance, businesses such as foreign hotels or foreign airlines, which allow online bookings by India-based customers, may be liable to pay 2% EL on the consideration received from Indian customers (subject to satisfaction of other conditions for being liable to 2% EL). Even MNCs with internal Enterprise Resource Planning (ERP) systems facilitating any of the above online activities (say placing of orders by one group company to another group company) may be liable to the 2% EL.

This proposal may result in an overreach by bringing offshore brick-and-mortar businesses (conducting just one leg of the transaction online) within the ambit of a levy intended to tax the offshore digital economy.

Sweetening the deal for Sovereign Wealth Funds and Pension Funds

To attract foreign investment in India’s infrastructure sector, Finance Act 2020 had provided for 100% tax exemption, subject to certain conditions, to foreign Sovereign Wealth Funds (SWFs) and Pension Funds (PFs), on their income from investment in Indian infrastructure. Notably, the scope of “infrastructure” investments for this exemption is considerably wide to include investments in diverse sectors such as transport and logistics, energy, water and sanitation, telecommunication and social & commercial infrastructure (such as hospitals, tourism, education institutions, affordable housing etc).

To attract foreign investment in India’s infrastructure sector, Finance Act 2020 had provided for 100% tax exemption, subject to certain conditions, to foreign Sovereign Wealth Funds (SWFs) and Pension Funds (PFs), on their income from investment in Indian infrastructure. Notably, the scope of “infrastructure” investments for this exemption is considerably wide to include investments in diverse sectors such as transport and logistics, energy, water and sanitation, telecommunication and social & commercial infrastructure (such as hospitals, tourism, education institutions, affordable housing etc).

However, SWFs and PFs were facing difficulties in meeting certain conditions prescribed for availing the exemption. This may be corroborated by the fact that even though this incentive was legislated 10 months back, only one SWF has been granted this exemption so far by the Government of India.

Keeping this in mind, the Bill proposes to relax some of these conditions relating to prohibition on private funding, restriction on commercial activities, and direct investment in infrastructure. These changes should make it easier for SWFs and PFs to comply with the conditions for availing this exemption and hopefully, we would see more SWFs and PFs being granted approval for this exemption.

Liquidity boost for Foreign Portfolio Investors

Income of Foreign Portfolio Investors (FPIs) from securities in the form of dividend and interest is taxable at 20% plus surcharge and cess (except for certain specified interest income which is taxable at 5%), or a lower rate available under the applicable tax treaty. However, the provision fastening withholding tax obligation on the payer, with respect to such payments to FPIs, prescribes 20% as the withholding tax rate and does not consider the tax treaty rates. This resulted in an anomaly as withholding tax could exceed the tax rate otherwise applicable to an FPI as a result of a beneficial tax treaty, leaving the FPIs to claim a refund of the excess tax withheld.

The Bill proposes to resolve this anomaly by amending the withholding tax provisions to provide that tax on dividend and interest payable to FPIs is to be withheld at the lower of 20% (plus surcharge and cess) or the rate provided under a tax treaty, subject to the FPI furnishing its Tax Residency Certificate. This welcome change will help alleviate the liquidity impact of higher withholding rate on FPIs.

Reopening of income-tax assessments – greater certainty by rationalising the limitation period

Currently, India’s Income Tax Act 1961 provides for reopening of past tax assessments (17 years from the end of relevant FY in case of foreign assets and 5 or 7 years (depending upon quantum of income) from the end of relevant FY in other cases) if inter alia the tax officer has ‘reasons to believe’ that income has escaped assessment.

The Bill proposes to do away with the aforesaid timelines and provides that tax assessments cannot be reopened beyond 4 years from the end of the relevant FY. However, if the tax officer has material in his possession that income (represented as an asset) chargeable to tax has escaped assessment and amounts to or is likely amount to INR 5 Million or more for that year, tax assessments can be reopened within 11 years from the end of the relevant FY.

These provisions are likely to provide succour to foreign businesses with India income-tax exposure, by reducing the realistic / practical timeframe for assessment reopening from 7 years to 4 years.

The Bill also proposes certain other changes that are largely welcome, such as –

* The term “liable to tax”, used in several tax treaties, remains undefined in treaties as well India’s domestic law. The Bill proposes to include the definition of this term in India’s domestic tax law, with the definition being in line with international understanding of the phrase;

* Reconstitution of the Authority for Advance Rulings to expedite disposal of advance ruling applications (however the proposal to include only serving tax-officers in the reconstituted Board for Advance Rulings may be relooked);

* Excluding dividend income while computing tax on book profits (referred to as “Minimum Alternate Tax” or “MAT”) payable by foreign companies.

Conclusion

Considering that the Bill is only in proposal stage for now (and will be enacted into legislation typically by March-end), fine-tuning some of the proposals would be helpful to put the international taxpayer community at ease.

In conclusion, the Government has rolled out the red carpet for foreign investors in various ways, including through tax-related measures starting with a historic corporate tax rate cut in 2019. We hope that these measures translate into greater capital inflows and deeper engagement of the international business community with India.