Offshore Transfers: The most prominent of these has been the non-consideration of the retrospective indirect transfer provisions which were introduced by the previous year's Finance Act. To rewind to that development, Indian revenue authorities had initiated litigation against Vodafone in 2007, seeking to tax the purchase by Vodafone of an offshore company which indirectly held assets in India. Claims were initiated on the basis that Vodafone had failed to withhold Indian taxes on payments made to the selling Hutch entity. The then provisions of the statute did not justify the levy of tax on gains from the transfer of an offshore asset between two non-residents and the matter was litigated up to the Supreme Court of India, which ruled in favour of Vodafone. The Supreme Court held that no Indian tax was required to be paid or withheld on that transaction as per the existing source rules for capital gains. This judgment was delivered in January 2012. A few weeks later, the Finance Act, 2012 introduced retrospective provisions "clarifying" the intent behind the Indian source rules and levying Indian tax on the transfer of offshore assets if such assets derived substantial value from India. As the provisions were introduced in a knee-jerk manner, they did not consider key questions relating to the applicability of indirect transfer provisions to listed companies, attribution of value, adjustment of cost of acquisition, availability of treaty benefits and foreign tax credits, etc. Unsurprisingly, the enactment lead to widespread investor discontent, and foreign direct investment into India fell sharply over the next quarter. In response, a high profile committee was set up under the leadership of Dr. Parthasarathi Shome to examine the indirect transfer provisions as well as the GAAR provisions which were also introduced by last year's Finance Act. While this year's Budget factors in the proposals made to the GAAR regime, no mention has been made as regards the proposals on indirect transfers in spite of the substantial efforts invested by the Shome committee and stakeholders in attempting to bring about clarity. This means that the retrograde provisions from last year's Finance Act continue to be applicable, and the inconsistencies flowing from their hasty conceptualization will carry over to this year, along with a validation clause which permits the overturning of court judgment in aid of these provisions. This raises questions over the status of the rule of law in India and is perhaps the most disappointing aspect of this year's Budget.
Definition of Royalty: Another retrospective amendment introduced last year related to the definition of royalty, which was expanded, with retrospective effect, to include several payments which would not be in the nature of royalty. Subsequent to this amendment, several Indian court/tribunal rulings have reconfirmed that in a situation where the payments are received by a non-resident situated in a tax treaty jurisdiction, the narrower definition contained in the tax treaty should apply. It would have been a positive measure to reconsider the wide nature of the deeming fiction introduced in 2012. Instead, the Budget has proceeded to retain the broad definition of royalty and to tax royalties at the rate of 25% on a gross basis, a retrograde move which is likely to be a big blow to several industries.
MAT on Foreign Companies: It would also have been useful to have clarity on the applicability of Indian minimum alternate tax (MAT) to foreign companies. Considering that the MAT is a minimum level of tax required to be paid by a company on overall profits, it would logically be applicable to companies which are taxable in India on their worldwide income i.e. Indian resident companies. In a situation where the company is non-resident, it would not be appropriate to levy Indian tax at a specified percentage of book profits of the company, irrespective of the threshold of involvement of the company with India. At the most, such a tax should only be applicable with respect to the Indian source income of such a company. However, the current language of the MAT provisions is not clear on this issue and the matter has been litigated upon and discussed on a fairly constant basis.
Capital Gains on unlisted securities: Another point in which some clarity would have been helpful is the beneficial rate of 10 per cent introduced by last year's Finance Act, on capital gains from the disposition of unlisted securities by a non-resident. As per the explanatory notes, the amendment was made to allow for parity between private equity investors and FIIs in terms of capital gains tax rates, since foreign institutional investors are entitled to a 10 per cent rate on capital gains. Unfortunately, the language contained in Finance Act, 2012 made the rate applicable only to gains from the disposition of unlisted "securities", with securities being defined as per the Securities Contract and Regulation Act, 1956 (SCRA). As case law in the context of the SCRA prescribes marketability as a precondition for the classification of an instrument as a security, and does not consider shares of private limited companies as 'security', the intended consequence of the amendment was not achieved. There continues to be ambiguity as to whether private equity investors will be eligible to the 10 per cent rate on sale of shares of private limited companies. With slight redrafting the entire controversy could have been put to rest, and the move would have provided a significant fillip to private equity investor sentiment.
Guidance on income characterization: The Budget could have also looked at adopting guiding principles similar to those introduced by countries such as Singapore in relation to the characterisation of investment income as business income or capital gains, to resolve long standing issues relating to the tax treatment of investments. This would have resolved issues for a number of Foreign Institutional Investors who face the challenge of characterisation of income as capital gains even where such income ought to have been classified as business income and not taxable in India in the absence of a permanent establishment (where treaty benefits are available).
Tax litigation and tax payer rights: There was also scope to introduce positive measures in relation to the tax litigation mechanism - while the FM has paid lip service to the state of tax administration in the country by initiating the setup of a review committee, it would have helped to prescribe a definitive timeline or agenda for the implementation of the reform process. A key aspect which has also not been considered is the question of tax payer rights and also abuse of process by the tax authorities. Time and again over the past year, the Courts have stated/discussed the high-handed approach of the tax authorities towards disputes. While the Finance Minister stated the intent of a having a non-adversarial tax process, the same can only be achieved if there are measures introduced to provide statutory rights for taxpayers as well as to curb the abuse of process of law. However, the Finance Minister has chosen to ignore the calls for these measures.
In sum, we come away from the Budget with a stronger sense of what could have been accomplished, and how significantly those accomplishments could have rejuvenated the Indian investment climate, rather than a recollection of the measures in fact put in place. It can only be hoped that the inaction shouldn’t prove too damaging, considering the slowing growth rate and the looming threat of an investment rating downgrade.
(Excerpts taken from "India Budget 2013 : Where's the excitement?" - a study released by Nishith Desai Associates).
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