For International Business Community
February 29, 2016
INDIA BUDGET 2016: WORTH AN OSCAR OR TWO, BUT NOT A CLEAN SWEEP!
The Indian Finance Minister Mr. Arun Jaitley announced India’s 2016 budget proposals (“Budget”) before the Parliament earlier today. The Finance Minister has focused on remedying a number of critical points of concern to foreign investors and he certainly deserves a few Oscars for addressing some painful issues. The Government has continued the path of systemic reforms by bringing about a number of changes to the tax and regulatory framework. These reforms include relaxing foreign investment limits in certain key sectors. A number of other low hanging fruits such as removing dividend distribution tax for REITs and InvITs (Real Estate Trusts and Investment Trusts respectively) and reducing the long term capital gains tax on unlisted securities of private companies from 20% to 10% have been addressed as part of the Budget. Importantly, the Government has stuck to the fiscal deficit target of 3.5% of India’s gross domestic product for FY 2016-17.
In the last year, India has been an outlier of growth in the global economy with economic growth accelerating to 7.6% in FY 2015-16. This has been amidst a global economic slowdown and increased turbulence in the global financial markets. The Government has come out with new initiatives such as the Start-Up Policy and the Make in India initiative with a view to providing a renewed thrust to different sectors of the economy. The Budget 2016 is an extension of various such initiatives and the Government appears to have taken into consideration several inputs from the industry and stakeholders in introducing its reforms.
On the regulatory side, significant relaxations have also been announced in respect of the Foreign Direct Investment Policy (“FDI Policy”), including allowing foreign investment in insurance and pension sectors under the automatic route upto 49% as well as allowing for 100% foreign investment under the automatic route in case of asset reconstruction companies and entities engaged in marketing of food products produced and manufactured in India. Similarly, the investment limit for individual foreign investors in stock exchanges has been increased from 5% to 15%, which is important in the context of the proposed listing of the Bombay Stock Exchange and the National Stock Exchange. However, similar relaxation for foreign investment in power exchanges and commodity exchanges has not been announced. The Budget further proposes to expand the basket of eligible FDI instruments to include hybrid instruments. This may allow for innovative structures to be effectuated.
The Government has also recognized that the bond markets in India need greater depth. For this purpose, they have announced that large borrowers will be encouraged to meet their financing needs through the market mechanism. In similar vein, Foreign Portfolio Investors (FPI) will also be allowed to invest in unlisted debt securities issued by corporates and pass through securities issued by securitization SPVs. While these moves will assist in deepening the bond market, one will have to wait to see the guidelines issued by the Reserve Bank of India in this regard.
On the tax side, last year the Government had proposed a gradual reduction in corporate tax rates from 30% to 25% over a period of four years. The Government appears to have taken the first step in this direction by providing that new manufacturing entities that are set up, will be entitled to a lower rate of 25% plus surcharge and cess on meeting certain conditions. Furthermore, the corporate tax rate is proposed to be lowered to 29% for a domestic company whose turnover in the FY 2014-15 does not exceed INR 5 crores (USD 800K). However, for large companies, while the Government has proposed phasing out incentives such as limiting accelerated depreciation, other investment linked incentives etc., it has desisted from reducing corporate tax rates this year. Another surprising change has been the introduction of a new dividend tax to be levied in the hands of an identified class of shareholders, i.e. those who receive dividend of more than INR 1 million in any financial year. This is a new tax apart from the existing dividend distribution tax which is levied in the hands of the company paying dividend.
On the positive side, the Government has reduced the long term capital gains tax rate levied on the sale of shares of unlisted private companies to 10% from 20% for foreign investors. It has further reduced the holding period for an investment to qualify as long term capital asset to 2 years from the earlier qualifying period of 3 years. The reduction in rates for foreign investors will provide significant relief and re-emphasize the commitment of the Government to making India an attractive investment destination for foreign investors.
The fund industry was a major beneficiary of the Budget proposals last year and continues to benefit in this year’s proposals. The Government last year had permitted foreign investment into Alternative Investment Funds (AIFs) under the automatic route. However, significant ambiguity was prevalent on distributions made to foreign investors by Category I and Category II AIFs where the withholding tax provisions provided for a 10% withholding rate. The Budget has now proposed that benefits under tax treaties will be extended to non-residents with respect to distributions from an AIF to such non-residents. This move will enable Indian GPs to structure fund raising through unified structures as against co-investment structures without any tax leakages. In similar vein, the Government has also eased the safe harbor norms for fund managers in India, and mere control or management of any business from India will not constitute a business connection. However, the expectation of easing a number of other safe harbor norms for fund managers has not been met.
REITS and InvITs have also been on the radar of the Budget this year. One issue that the industry is facing is that the upstreaming of amounts through dividends to REITs/InvITs is subject to dividend distribution tax (“DDT”). The Budget proposes the removal of such DDT. With these changes in addition to those proposed last year, it is hoped that REITS / InvITs will finally take off in India.
The Government has also followed up on its announcement for Start Ups last month by providing various tax incentives. The Government has also introduced incentives for R&D by allowing worldwide royalties derived from patents developed and registered in India to be taxed at a lower rate of 10%. This follows the international practice usually accorded in many countries to provide patent box regimes / incentives for R&D.
An interesting measure introduced in the Budget is the proposed tax incentives applicable to units that are set up in an International Financial Services Center (IFSC). The first IFSC has been set up at the GIFT city with the intent of capturing a share of the international offshore financial services market.
While there have been a number of positive measures that have been announced, the Budget still leaves an overhang over some important issues such as the retrospective tax on indirect transfers, place of effective management (“POEM”) and General Anti Avoidance Rules, which leave it short of an Oscar clean sweep.
The Government has decided to postpone the introduction of the POEM Rules to FY 2016-17 with detailed provisions being introduced on the treatment of when a foreign company becomes a resident of India in the first year. The change introduced last year with respect to the POEM Rules was an ill thought out decision and it would have been much better if the Government had decided to revert to the old provisions which provided for the “control and management” test for a foreign company to be treated as resident in India. Similarly, the General Anti Avoidance Rules continue to be effective only from FY 2017-18 and it is hoped that the rules for their application will provide for enough checks and balances to ensure tax payer protection.
The Budget has tried to tackle the ghost of the retrospective nature of the indirect transfer provisions by providing for a dispute resolution scheme for resolving such disputes. The Scheme provides that if tax payers withdraw a litigation / arbitration arising out of such issues, the Government will waive the interest and penalties on such tax payable. It is unfortunate that the Government has not taken the bold step to bury the ghost by removing the retrospective nature of the provisions. Even today, there are neither rules that are in place to determine fair market value for application of the indirect transfer tax provisions nor are there provisions to determine the manner of apportionment of gains attributable income purportedly derived from India. These retrospectively applicable indirect transfer tax provisions and the absence of legislative certainty in this regard will continue to haunt the Government in the medium term.
The Budget also proposes an equalization levy, which will affect the online advertisement income earned by foreign companies. A fall out of the discussions during OECD BEPS Action Plan (though not finally accepted), the Budget provides for a 6% equalization levy in respect of payment of advertisement revenues to foreign companies. In the normal course of things, this would not have been a taxable transaction and this provision can have significant ramifications for companies seeking to do business in India. Another fall out of the OECD BEPS Action Plan seems to be the country by country reporting standards which have now been introduced for companies that meet certain thresholds.
The Government has used the Budget to make incremental progress and introduce changes in the sphere of tax legislation, without making any big bang reforms. It has instead focussed on the resolution of some of the smaller complexities in Indian tax legislation which have been pain points for foreign investors. Apart from substantive changes to the law, there have also been a number of procedural changes introduced with the intention of facilitating early resolution of disputes and reducing litigation backlog. The changes proposed by the Government, however, do not amount to bold action that could have sent out the strong message of welcoming foreign investors with open arms to India.
We will send a more comprehensive analysis and further insights on the 2016 Budget proposals over the course of the day.
Join us for an interactive Webinar on Wednesday, March 2, 2016 (India time) for insights on India’s 2016 Budget. Do also visit Nishith.tv for videos and insightful discussions on the impact of the Budget on key industries.
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