Initial Thoughts and Comments on the NDA government’s First Budget

At the first glance, Budget 2014 seems to be setting the foundation for the subsequent Budgets of the NDA Government. To be fair to Arun Jaitley, he only had 6 weeks to prepare the Budget under very complex and challenging circumstances. Thus, he has tried to maintain status quo without rocking the ship and at the time not going overboard with significant benefits..Some of the statements made by Arun Jaitley provide an indication of the intent of the Government. For example, the constitution of a High Level committee to interact with trade and industry on a regular basis, reducing profligacy and trying to curtail the budget deficit, etc. are all steps in the right direction provided they are implemented properly..One of the disappointments of this Budget is the retention of retrospective amendments to tax laws (like taxation of indirect transfers, taxation of royalty etc.). Since the NDA had severely criticised the tax policies of the UPA Government during its election campaign, especially in connection with the retrospective amendments and even coined a term “tax terrorism”, it was widely expected that it would be withdrawn. While the FM has tried to soothe the nerves of the investors and industry by clarifying that the Government would not ordinarily resort to retrospective taxation, he has also stated that the sovereign right of the Government to undertake retrospective legislation cannot be taken away..However, he has assured that all fresh cases arising out of the retrospective amendments made by the Finance Act, 2012 in respect of indirect transfers will be scrutinized by a High Level Committee to be constituted by the CBDT, before any action is initiated in such cases. No further clarity has been provided on other ambiguous aspects, like what constitutes ‘substantial value’, under what circumstances the indirect transfer related provisions shall not be attracted, etc..In the ensuing paragraphs, we have presented a snapshot of the some of the proposed changes to the Income Tax Act, 1961 (“IT Act”) presented in the Budget..Grant of pass through status to REITs and Invits.The Securities and Exchange Board of India (“SEBI”) had released draft regulations governing Real Estate Investment Trusts (“REITs”) as well as consultation paper for Infrastructure Investment Trusts (“Invits”) and the same are yet to be formally notified..In what seems to be the most important tax simplification measure of Budget 2014, it proposes to introduce a specific taxation regime for REITs and Invits, effective from October 1, 2014, providing the way the income in the hands of such trusts is to be taxed and the taxability of income distributed in the hands of unit holders of such trusts. The specific taxation regime would include the following:.a. REITs as well as Invits together are to be defined as ‘Business Trust’ and have been granted tax pass through status in respect of interest income..b. Interest income received from the Special Purpose Vehicle (“SPV”) will not be taxed in the hands of the Business Trust, but will be taxed at the rate of 5%[1] in the hands of non-resident unit holders and at the applicable tax rate in the hands of resident unit holders at the time of distribution. Further, while payment of interest by the SPV to the Business Trust will not be subject to withholding tax, payment of interest by the Business Trust to the unit holders will be subject to withholding tax at the rate of 5% in case of non-resident unit holders and 10% in case of residents unit holders..c. Dividend paid by the SPV will be subject to dividend distribution tax in the hands of the SPV. Such income will be exempt in the hands of the Business Trust and the unit holders at the time of distribution..d. Capital gains on disposal of assets by the Business Trust shall be taxable in the hands of the Business Trust at the applicable rate. Further, any other income of the Business Trust shall be taxable at the maximum marginal rate. Any such income when distributed will be exempt from tax in the hands of the unit holder..e. Gains on sale of listed units of a Business Trust on which STT is paid arising in the hands of the unit holders (other than the Sponsor) would be exempt if it is long term capital gains and would be taxable at the rate of 15% if it is short term capital gains..f. At the time of settlement of the Business Trust, transfer of shares of the SPV by the Sponsor in exchange for units of the Business Trust will be exempt from tax. However, when such units are transferred by the Sponsor, the gains will be taxable in their hands..Boost to the manufacturing sector.Under the existing provision of the IT Act, a taxpayer is allowed a deduction in respect of the whole of any expenditure of capital nature (other than expenditure on land, goodwill and financial instrument) incurred wholly and exclusively for the purpose of any specified business carried on by him in the financial year[2]. A list of specified business was set out covering eleven businesses; it is proposed to include two new businesses within the scope of “specified business” to promote investment in these sectors, namely, laying and operating slurry pipelines for the transportation of iron ore and semi-conductor wafer fabrication manufacturing units. Further, it is proposed that any asset in respect of which a deduction is claimed, shall be used only for the specified business for a period of eight years beginning with the financial year in which the asset is acquired. This has been introduced in order to ensure that the capital asset on which investment linked deduction has been claimed is used for the purpose of the specified business..With the intention of encouraging companies engaged in the business of manufacture or production to invest substantial amount in acquisition and installation of plant and machinery, the Finance Act 2013 introduced an additional deduction of 15% of cost of new assets in the nature of plant and machinery, if the taxpayer invests a total sum of more than INR 100 crores in new plant and machinery[3] during the financial years 2013-14 and 2014-15. While this benefit continues, in order to extend this investment allowance to medium size investments, it is proposed to provide an additional investment allowance for manufacturing companies at the rate of 15% of the cost of new plant and machinery, if the investment is made during any financial year in excess of Rs. 25 crores. The benefit is available for investments upto March 31, 2017..Tax incentives for the Power Sector.Under the existing provisions of the IT Act, a deduction of an amount equal to 100% of the profits and gains derived from the business for ten consecutive assessment years is allowed to an undertaking, which is set up for the generation, transmission and distribution of power, if it begins to generate, transmit, distribute power, or undertakes substantial renovation of its existing network by March 31, 2014[4]. It is proposed to extend this date to March 31, 2017..Measures to reduce tax litigations (including simplification of Transfer Pricing provisions).Another positive step was in the direction of reducing tax litigation, which has reached alarming proportions. To this end, it is proposed to expand the provisions of Advance Rulings to permit resident taxpayers to obtain an advance ruling in respect of their income tax liability above a certain threshold. Further, additional benches of the Authority for Advance Rulings are proposed to be constituted. Additionally, for simplification of transfer pricing provisions, it is proposed to introduce a ‘roll back’ provision in the Advance Pricing Agreement (“APA”) scheme, so that an APA entered into for future transactions is also applicable to international transactions undertaken in the previous four years in specified circumstances; to introduce a range concept to determine arm’s length price and to permit use of multiple year data for a comparability analysis under the transfer pricing regulations..Increase in the holding period of certain securities to be classified as Long Term Capital Assets.Capital Gains arising to an investor from the transfer of unlisted shares (includes unlisted equity and preference shares) and units of Debt Linked Mutual Fund Schemes (“DLMFS”) proposed to be considered as Long Term Capital Gains only if the unlisted shares/ units are held for a period of more than 36 months as against for a period of more than 12 months as it existed presently..Double whammy for DLMFS.In addition to the increase in the holding period for units of DLMFS , the concessional rate of 10% tax on long-term capital gains available to such units is also proposed to be withdrawn. Thus, it is a double whammy for debt-based schemes. The investors need to hold the units for a longer period to qualify them as long-term capital assets and they will have to pay tax at the rate of 20%..This could have a significant impact on the DLMFS..Removing the ambiguity regarding taxation in the hands of Foreign Portfolio Investors.Currently, there is no provision, which specifically deals with characterisation of income in relation to transaction in securities by Foreign Portfolio Investors (“FPIs”), i.e. whether the income is in the nature of business income or in the nature of capital gains. The matter has been subject matter of significant litigation and Courts have held that it is a fact-specific analysis and a number of factors like volume of transaction, frequency, size of purchase and sale, pattern of trading activity, etc. have to be seen cumulatively to arrive at a conclusion. The Finance Bill 2014 proposes to specifically provide that investment in securities by FPIs in accordance with SEBI regulations would be treated as “capital asset”, thereby defining the character of income arising from transfer of the securities to be in the nature of capital gains..This amendment would end the uncertainty revolving around characterisation of income in the hands of FIIs on transfer of securities..No tax deduction for expenses incurred under Corporate Social Responsibility.The Companies Act, 2013 has mandated compulsory Corporate Social Responsibility (“CSR”) expenditure out of the average net profits of a company[5]. Such CSR expenditure, being an application of income, shall not be allowed as a tax-deductible expenditure under the IT Act.[6].Relief in cases of withholding defaults.The existing provisions of the IT Act provide that certain payments, such as interest, commission or brokerage, rent, royalty, fees for professional / technical services made to a resident shall not be allowed as a tax deductible expenditure, if tax on such payments was not deducted, or after deduction was not paid within the prescribed time.[7] In order to reduce hardship, it is proposed that in case of non-deduction or non-payment of tax deducted at source on such payments made to residents, the disallowance will be restricted to 30% of the amount of expenditure claimed..Incentivising borrowers to look for long term overseas commercial borrowing.Currently, interest paid to non-residents by an Indian company on foreign currency loans from a source outside India under a loan agreement or through issue of long-term infrastructure bonds is subject to concessional withholding tax rate of 5%. It has been proposed that the benefit of lower withholding of 5% on interest paid to non-residents be extended to all long-term bonds issued during the period starting from October 1, 2014 until June 30, 2017. In addition, it is proposed to extend the existing benefit of lower withholding for a further period of two years in respect of foreign currency loans from outside India as well as long-term infrastructure bonds issued until June 30, 2017. This benefit is also proposed to be extended to interest payments by the Business Trust to non-residents..Increase in the effective rate of Dividend Distribution Tax.The divided income paid to the shareholder / unit holder is proposed to be grossed up for the purpose of computing the additional tax on income distribution under the IT Act[8]. This would effectively increase the rate of dividend distribution tax from 16.995% to 20.474%[9]..Extension of benefits available for foreign dividends.In order to encourage Indian companies to repatriate foreign dividends into India from specified foreign companies (in which Indian companies hold 26% or more equity shares), it is proposed to extend the benefit of lower rate of taxation of 15%, without any sunset date..Relief to non-residents on capital gains from government securities.The existing provisions of the IT Act provide that certain transactions shall not be considered as transfer for the purpose of charging capital gains[10]. It is proposed to provide that transfer of a capital asset by one non-resident to another non-resident, being a government security, carrying a periodic payment of interest, shall not be considered as transfer for the purpose of charging capital gain if the transfer is made outside India through an intermediary dealing in settlement of securities. This proposal would facilitate listing and trading of government securities outside India..No change in tax rates for the tax rates.There has been no change to the existing tax rates for either corporate or individuals, HUFs, firms etc. The additional surcharge of 10% introduced by the Finance Act, 2013 for one year has now been extended to the financial year 2014-2015. Education cess would continue to be levied at 3%..Benefits for individual taxpayers.On the individual tax front, personal income tax exemption limit has been increased by INR 50,000 to INR 2,50,000 in the case of taxpayers who are below the age of 60 years and to INR 3,00,000 in the case of citizens between the age of sixty and eighty years. In addition, the investment limit under Section 80C of the IT Act has been raised to INR 1,50,000 from INR 1,00,000. The deduction limit on account of interest on loan in respect of self-occupied house property has also been raised from INR 1,50,000 to INR 2,00,000..SR Patnaik is a Partner at the Mumbai office of Amarchand Mangaldas. Views expressed in the article are personal.[1] Tax rates provided in this article are exclusive of surcharge and cess unless otherwise provided.[2] Section 35AD of the IT Act[3] Section 32AC of the IT Act[4] Section 80-IA of the IT Act[5] Section 135 of the Companies Act, 2013[6] Section 37(1) of the IT Act[7] Section 40(a)(ia) of the IT Act[8] Sections 115O and 115R of the IT Act[9] The rate provided is inclusive of surcharge and cess[10] Section 47 of the IT Act