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India Budget Targets Tax Certainty

by Mary Swire,, Hong Kong

15 July 2014

India's new Finance Minister, Arun Jaitley, has set out plans to comprehensively reform the tax system over the next five years to improve tax certainty and raise the tax to GDP ratio, but his text lacks the particular measures needed to deliver on such objectives.

The Budget was overshadowed by the announcement that the Government will stand by the previous Administration's controversial decision to allow retrospective tax measures. It was widely expected that the Government would repeal the amendment to send a message to international investors that they can be sure of their future tax liability. Instead, Jaitley said that retrospective law changes will only be applicable in "genuine" cases.

He said: "The sovereign right of the government to undertake retrospective legislation is unquestionable. However, this power has to be exercised with extreme caution and judiciousness keeping in mind the impact of each such measure on the economy and the overall investment climate."

Jaitley said: "This Government will not ordinarily bring about any change retrospectively which creates a fresh liability." However, noting "a few cases had come up in various courts and in international fora" that were impacted by the retrospective tax law change, Jaitley made clear that the Government would not intervene, stating: "These cases are at different stages of pendency and will naturally reach their logical conclusion."

Jaitley stated: "We have decided that henceforth, all fresh cases arising out of the retrospective amendments of 2012 in respect of indirect transfers and coming to the notice of Assessing Officers will be scrutinized by a High Level Committee to be constituted by the [tax authority] before any action is initiated in such cases. I hope the investor community both within India and abroad would repose confidence on our stated position and participate in the Indian growth story with renewed vigor."

Another major announcement in the budget will hit foreign institutional investors that invest in debt-focused funds. These funds account for about 60 percent of assets under management in India's mutual fund industry. Previously able to shield gains from taxation in India if they lacked a permanent establishment and structured their investment to enable classification of gains as business income, investors will no longer be able to exploit the loophole to achieve tax-free gains, reports say, and, in a double hit, the Government announced that it is to increase the tax rate on short-term capital gains from 10 percent to 20 percent and will increase the period that such investments must be held to secure this concessionary rate from one year to three years.

While the tax rate is more favorable than the 40 percent rate in place on the income of non-resident companies with a permanent establishment in India, the announcement is expected to cause massive fallout for foreign investors in India, and in particular increase the tax liability of those holding derivatives with a less than three-year term.

After the changes, investment in debt funds is expected to remain a somewhat attractive investment (as taxable gains deriving from such investments are revised downward on account of inflation before tax is levied, unlike tax on bank account interest, the taxable base for which is not adjusted for inflation), but the requirement to hold such debt funds for at least three years to unlock the 20 percent rate on gains increases investors' exposure to risk. Therefore, the change is expected to deter investors from seeking exposure to debt funds – as a more volatile savings vehicle – just to derive a lower effective rate on gains, combating what Jaitley referred to as tax arbitrage.

With the closure of the loophole, the move is expected to force foreign institutions investors to route investments through companies in territories that have secured double tax agreements with generous tax relief arrangements, such as Singapore and Mauritius, despite ongoing concerns about the introduction of the General Anti-Avoidance Rules from 2015.

Controversy aside, the main beneficiaries of the Budget were low income earners and pensioners. The budget will increase the personal income tax exemption limit for senior citizens above the age of 60 years to INR300,000 (USD500), while the exemption limit for individual taxpayers below the age of 60 years is proposed to be raised to INR250,000 (both up INR50,000).

Other measures include the extension of the additional tax incentive on home loans to encourage people, especially young people, to own houses. The liberalized facility of five percent withholding tax on all bonds issued by Indian corporates abroad will be extended to June 30, 2017. The concessional rate of tax at 15 percent on dividends received by Indian companies from their foreign subsidiaries will be extended indefinitely.

Next, Jaitley said there is an urgent need to converge the current Indian accounting standards with International Financial Reporting Standards (IFRS). He said India will adopt the new Indian Accounting Standards (Ind AS) from the financial year 2015-16 voluntarily, and from the financial year 2016-17 on a mandatory basis.

On indirect tax, Jaitley confirmed that the federal government will look to push through the adoption of a goods and services tax by the end of this year, after it settles outstanding issues with state authorities.

The Budget envisages a 0.5 percent reduction in the deficit this year – from a projected level of 4.1 percent in 2014/15, to 3.6 percent of GDP in 2015/16.

TAGS: court | Finance | tax | investment | business | India | Mauritius | tax avoidance | interest | law | accounting | budget | Singapore | food | agreements | legislation | withholding tax | dividends | standards | trade | inflation | services

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