The Union Budget 2015 (‘Budget’ or ‘Finance Bill’) was presented in the backdrop of a need for a significant push to kick start the investment cycle. Given the debt overhang of the private sector on account of underperformance of their investments / projects, the Government had a daunting task of increasing public investments and yet balancing the fiscal discipline.
The Government is aware of the capital inflows (both domestic and foreign) that the alternative investments fund industry could mobilise and deploy, and thereby release some pressure on the public investment front. In this context, the following proposals of the Budget relating to the alternative investments fund industry are a welcome change.
1. Deferral of General Anti-Avoidance Rules (‘GAAR’): Not only has the implementation of the provisions of GAAR been deferred by two years, the investments already made and to be made up to 31 March 2017 are proposed to be grandfathered. It is also proposed that the GAAR provisions are implemented as part of a comprehensive regime to deal with the Base Erosion and Profit Shifting (‘BEPS’) project under OECD and aggressive tax avoidance. Hopefully, this should release some pressure on the level of protections sought at the time of exits.
2. Taxation of overseas transfer of assets (aka Vodafone issue): The Budget has provided much-awaited clarity on the taxation of transfer of share or interest in a foreign entity, which derives its value substantially from assets located in India (‘indirect transfer provisions’), although one expected more.
It is proposed that these indirect transfer provisions shall apply only where the value of assets located in India exceeds INR 100 million and the Indian assets represent at least 50% of value of all the assets owned by the foreign entity.
Furthermore, an exemption has being accorded to small shareholders, i.e. those (together with associated enterprise) who do not hold rights of control or management or more than 5% voting power or share capital or interest in this foreign entity. Similarly, certain benefits have been extended to offshore restructuring on account of mergers or demergers of these foreign entities.
Even where such shares or interest in foreign entities are deemed to be situated in India, only a part of the income as is reasonably attributable to assets located in India (to be computed in a manner as may be prescribed) shall be chargeable to income tax in India. The Finance Minister has also stated that concerns regarding applicability of indirect transfer provisions on dividends paid by foreign entities will be addressed through a separate circular.
3. Taxation of Domestic funds: The so-called pass-through has been extended to Category I and Category II Alternative Investment Funds (‘AIFs’). The income of these AIFs (other than the profits or gains from business) is chargeable to income tax in the hands of the investors and the AIFs are required to deduct tax at source in respect of such income at the rate of 10%. Furthermore, the Explanatory Memorandum also proposes to notify these AIFs to entitle them to receive income without deduction of tax at source. Given the exemptions provided, the income of the investors in these AIFs would also not be subject to minimum alternate tax (‘MAT’). These benefits have also been extended to AIFs set-up as companies and limited liability partnerships.
Given the objective of both these categories of AIFs of long-term capital formation, a specific deeming fiction to treat the income of these AIFs (arising from transfer of underlying securities) as capital gains, similar to what has been done for foreign portfolio investors, would have significantly helped in providing certainty to domestic investors and fund managers.
4. Residency to be based on place of effective management: If one were to look for one proposal that could have a significant impact on the offshore alternative funds investing in India, it is the provision determining residential status of the foreign companies. A foreign company shall be considered as a resident of India if, at any time during the year, it has a place of effective management in India.
The term place of effective management is defined to mean a place where key management and commercial decisions that are necessary for the conduct of business as a whole, are, in substance made. This definition is vague and capable of varied interpretation thereby causing uncertainty. While the Explanatory Memorandum proposes that a set of guiding principles to be followed in determination of place of effective management would be issued, one expects these to be issued as soon as possible to avoid uncertainty. Furthermore given the wider it may have on foreign investors investing in India, it is recommended that these guidelines are discussed with all stakeholders before they are finalised.
5. Management of offshore funds in India: The Budget has proposed comprehensive rules to promote management of offshore funds from India. By and large, the current provisions do not seem to cover management of AIFs but only those public market-focussed funds with a broad investor base. Having said that, it at least sets the roadmap and a framework that can be used as a base for making a case for the alternative investments fund industry.
6. Minimum Alternate Tax: The Budget has proposed a specific carve-out to capital gains income of Foreign Portfolio Investors (‘FPIs’) from MAT provisions. However, it may result in a presumption that the MAT provisions were in the first place applicable to foreign companies and explicitly excluded only a certain type of income arising to FPIs. This results in uncertainty regarding applicability of MAT to foreign companies and a clarification (after due deliberation with the stakeholders) would be welcome.
7. Black money: The Finance Minister stated that a comprehensive new law to deal with the issue of black money will be introduced in the Parliament. Under the new law, in case of concealment of income/assets or inadequate disclosures of foreign assets, the taxpayer could be prosecuted for a period of up to ten years and could also be subject to a penalty at the rate of 300% of the tax sought to be evaded. The initial glimpse of the proposals sound to be draconian and we only hope that there are enough safeguards in the new law that would help in avoiding harassment to resident investors holding offshore assets in accordance with the extant regulatory framework.
To summarise, in presenting the first full budget, the Government seems to have heard the voice of the industry and aims to foster a stable taxation policy. However, the specific provisions of the Finance Bill do not necessarily seem to be in the direction of providing a non-adversarial tax administration regime. To this effect, it is recommended that the provisions of the Finance Bill are appropriately deliberated with a wider set of stakeholders and reviewed with an eye to detail.
(Vikram Bohra is Partner and Devang Ambavi, Senior Manager, Financial Services Tax and Regulatory Services, PwC.)
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