We’ve not heard the last word on tax reforms yet

The Direct Taxes Code Bill, 2009 (DTC), which was released in August 2009 raised many concerns on minimum alternate tax (MAT), capital gains tax, residency test for foreign companies, general anti avoidance rules (GAAR), treaty override, exempt-exempt-tax (EET) scheme of taxation etc.

Industry participants, professional circles and stakeholders provided their thoughts and suggestions and after ten months, a revised discussion paper has been released.

Proposals relating to resurrection of exempt-exempt-exempt (EEE) scheme for specified contributions and abolishing presumptive basis of taxation of house property provide relief to individuals. It is also proposed that wealth tax will be levied broadly on the same lines as is being currently levied. Provisions relating to non-profit organisations have been rationalised.

To an extent, the paper addresses some of the major concern areas for corporate India, a surprise in the form of controlled foreign corporation (CFC) provisions as an anti-avoidance measure has been introduced. Passive undistributed income earned by a foreign company (controlled directly/indirectly by an Indian resident) would be taxable in India in the hands of the resident shareholders. This would have far reaching impact on corporate India’s overseas investment plans.

The changes impacting corporate India, which have been clarified in the paper, are briefly discussed below.

The revised proposals for computing MAT with reference to ‘book profits’ is definitely a welcome move. The earlier DTC proposals for computing MAT with reference to ‘value of gross assets’ faced huge outcry from stakeholders, as even loss making companies, liaison  offices and companies under liquidation would need to pay MAT. Though the revision provides a breather for corporate India, especially capital intensive companies, there is no clarity with reference to carry forward of MAT credit or rate of MAT.

Abolishing securities transaction tax (STT), the DTC proposed a uniform rate of tax for long-term and short-term capital gains. The exemption for long-term gains on listed shares was removed, resulting in taxation at rates upto 30%. Such a paradigm shift would have caused turbulence in the capital market.

The paper now proposes to compute capital gains on shares of listed companies or units of equity-oriented funds held for more than one year after allowing deduction at specified percentages, without any indexation. STT will continue at calibrated rates.

The controversy of characterisation of income earned by foreign institutional investors (FIIs) is now settled by deeming it as capital gains. Further, FIIs would discharge their taxes by paying advance tax and TDS provisions would not apply.

Under the DTC, a foreign company with control and management even partly situated in India would be treated as an Indian resident, subject to tax on its global income.

This created a fear that, several foreign companies would be treated as resident in India, adversely impacting foreign capital inflows.

Following internationally accepted practices, it is proposed that the residency of a foreign company would be determined by its ‘place of effective management’ i.e. if key management and commercial decisions necessary for the conduct of the entity’s business are taken in India, it would be considered as an Indian resident.

Though this is a welcome move from the earlier proposal, determining the place of effective management may be challenging, resulting in a tussle with the tax authorities.

In a single stroke that would have rendered all tax treaties entered into prior to DTC redundant, the DTC proposed that in case of its conflict with tax treaty provisions, the one that was notified later would prevail. This treaty override met with heavy criticism as being against the Vienna convention’s spirit.

As a positive development, the provisions more beneficial to the taxpayer would remain applicable, subject to certain anti-abuse measures (GAAR/CFC).

Sweeping DTC proposals introducing GAAR, seemingly giving discretionary powers to tax authorities created a furore. The paper attempts to dilute this by clarifying that GAAR will cover only those cases where the arrangement, besides obtaining a tax benefit (above specified threshold limits), is not at arms length, represents misuse or abuse of the DTC provisions, lacks
commercial substance or is not for bona-fide business purposes.

Till operational guidelines are issued, it is difficult to gauge the extent to which the paper dilutes GAAR.

The DTC had grandfathering provisions for special economic zone (SEZ) developers, but not for units operating in SEZs. Now it is proposed that SEZ units coming into operation before 1.4.2011 (not thereafter) will only be entitled to tax holidays. Will SEZ developers be able to sell units after 1.4.2011 if they are not entitled to tax holidays?

Looking at the broader picture, the paper attempts to resolve most concerns raised by industry participants. However, introduction of CFC rules may spoil the party. It is now once again a wait and watch as to what form the DTC finally takes.

The writer is executive director, PricewaterhouseCoopers. Views are personal.