The Hindu Business Line : Effect of new tax proposals on companies

The introduction of the Direct Taxes Code marks an important change in the fiscal regime for taxpayers in India. The Code has factored best practices adopted by different countries and experience based on the judicial interpretation. This article focuses on the critical changes vis-À-vis the extant law which affect Indian and foreign corporate entities.

Rate Change

The Code has proposed a reduction in the tax rate to 25 per cent for both Indian and foreign companies.

In addition to corporate tax, an additional 15 per cent tax is applicable in the case of foreign companies operating through branches — similar to the dividend distribution tax of 15 per cent on Indian companies.

The tax rate arbitrage in favour of Indian companies that exists now is proposed to be done away with.

Accordingly, subject to commercial issues such as limitation of liability, foreign corporate entities may prefer to operate in India as branches rather than through incorporated subsidiaries.

Capital Gains

Taxability of capital gains was based on the nature of capital asset being short term or long term. The Code proposes to do away with such a distinction and provide indexation if the asset is sold after one year from the end of the financial year from which the asset is purchased.

The earlier method which allowed foreign investors protection against foreign exchange fluctuation is done away with. Also, the benefit of differential tax rate for long term and short term asset is done away with.

In addition, direct or indirect transfer of capital asset situated in India is proposed to be brought into the Indian tax net, thereby covering transactions such as in the case of Vodafone.

Specific income exemptions provided based on geography no longer exists. However, the Code proposes investment linked incentives to a set of industries.

The impact of such a change will primarily be felt in case of those projects where financial investors have invested for an identified period, based on the promised tax breaks available in such projects. Deductions that are eligible have been specified in the Code, thereby leaving no room for interpretation play.

Minimum Alternative Tax

It is also proposed that MAT be computed based on capital employed by the business. Such tax is proposed to be levied at 2 per cent of the value of the gross assets. If there are two companies engaged in different industries having similar turnover and profitability for a particular year but having substantially different capital base due to nature of industry in which they operate, the company which has employed larger capital may be required to pay higher MAT.

Thus, the requirement on the part of companies to pay MAT at 2 per cent of value of gross assets, without deduction for liabilities, may not reflect the fair profitability for taxation. The effect is felt more as such MAT is not available for carry forward and set off in subsequent years against the normal tax liability.

Business income

The Code proposes that income of each business be computed separately and taxes be paid after consolidating the results of all the businesses. The loss suffered from such businesses is proposed to be allowed to be carried forward indefinitely, which is a welcome change from the current carry forward eligibility period of eight years.

Residential status

Currently, foreign companies are regarded as Indian tax residents only if the entire control and management is exercised from India. The Code proposes to change this position and treat a foreign corporate as Indian tax residents, even where only part of the control of the foreign corporate is exercised from India.

In this regard, it should be noted that a resident company is taxed on its worldwide income. This would necessitate greater care on the part of foreign companies to ensure that they are not taxed as Indian residents.

Transfer Pricing

In addition to the key proposals such as change in definition of Associate Enterprises, the Code proposed to introduce Advance Pricing Agreement (APA), to enable MNCs to have certainty on their pricing strategy for Indian markets. Another important change is the requirement to file the Accountants Report with the transfer pricing officer as against the assessing officer.

General Anti-Avoidance Rules

The Code empowers the Commissioner of Income Tax to examine whether an arrangement lacks commercial substance and is designed to take only tax benefit. The onus is on the taxpayer to establish that arrangement was not merely for tax reasons. If the Commissioner is not satisfied, he can disregard the arrangement and charge tax as if the arrangement does not exist.

Treaty Interpretation

The Code also provides, in case of inconsistency, the provisions of the law which is later in time would prevail. Further, the definitions of royalty and fees for technical services have been widened. This read with the above proposal could make restrictive definition in the treaty wider than what is envisaged to be covered when the agreement between two countries are entered into.

Though there are a number of changes which positively impact a taxpayer there seems to be some amount of rigidity proposed in the Code which may adversely affect the smooth functioning and, therefore, willingness to comply with the Code. Specifically, changes which affect capital-intensive industries, such as MAT on gross value of assets, should be relaxed or amended.

(The authors are Partner and Associate, respectively, Economic Laws Practice.)

More Stories on : Taxation | Insight | Corporate

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Cost audit

Effect of new tax proposals on companies

Sifting fact from perception

60 Seconds Chief