Union Budget, 2021 - A good old fashioned detox

As expected, Union Budget 2021 leans on the side of fiscal prudence and offers little by way of big bang tax breaks or incentives. But, the Government has used this year’s budgetary exercise to clean up and rationalize some direct tax provisions. This includes a revamp of the tax assessment and dispute resolution process, mitigation of compliance burden for small taxpayers and clarifying some litigated tax issues. In this article, we reflect on some of these key tax proposals.

In a bid to overhaul the tax assessment and disputes process, the Government has proposed to abolish the income tax settlement commission and the Authority of Advance Rulings. It proposes to replace the Authority of Advance Rulings with a Board of Advance Rulings, from where appeals can be filed directly before the High Court. Government has also introduced a dispute resolution committee for small taxpayers.

In addition, the Government also plans to make the Income Tax Appellate Tribunal proceedings faceless (as is in the case of tax assessment before tax authorities). At present, tax assessment can be reopened for a period of four assessment years (which increases to six assessment years in case income has escaped assessment because of non-disclosure of information by the taxpayer). In case income which has escaped assessment relates to a foreign asset, the limitation period for reassessment is sixteen years.

In a big shift, the Government has reduced the re-assessment limitation period to three years (which may increase to ten years only when the assessing officer is able to bring evidence on record to demonstrate that income exceeding INR 50 lacs has escaped assessment). Indeed, the efficacy of such reduced timelines will depend upon how strictly the assessing officer is held to the higher standard of bringing forth evidence to reopen tax assessment beyond three years.

As regards tax incentives, changes are few and mostly tilted towards ensuring the success of Indian Financial Service Centre. The Government is bullish on promoting IFSCs as a home for funds and international aircraft leasing. Additionally, the Government has relaxed some of the conditions applicable to sovereign wealth funds to claim tax exemption from investments in specified infrastructure enterprises – such relaxation is key ensure the mobilization of foreign government’s funds into India. Other tax incentives included one year extension to the tax holidays for start-ups and affordable housing projects.

There are several litigious issues that the Government has sought to clarify through its tax proposals this year. The availability of depreciation on goodwill has been a contentious issue –both in the context of vanilla acquisitions and amalgamations. The Government has proposed amendments to ensure that depreciation will no longer be available on goodwill going forward. The cost incurred to purchase any goodwill will only become the cost of acquisition to compute capital gains in case of any future sales.

The Government has also clarified that a slump sale structured as an exchange or consummated through a court approved scheme would be taxable – even if they not fall within the technical definition of a sale. Other such changes include, limiting employer’s ability to claim a deducting for employees contribution to provident funds, etc. in case of untimely deposit, defining the expression ‘liable to tax’, clarification in equalization levy provisions, etc.

As regards taxation of dividends, rationalization of TDS rates for FPIs is a key change to neutralize the impact of Supreme Court’s decision in PILCOM. FPIs are governed by a standalone TDS provision that sets a flat TDS rate of 20% on all income earned by an FPI (other than capital gains). This meant that even if FPIs were entitled to a lower withholding tax rate under tax treaties, TDS would be deducted at 20%; the FPI would then need to claim a tax refund.

This issue became more glaring when India shifted from the DDT to classical dividend tax system. Finance Bill, 2021 has now aligned the TDS rate applicable to FPIs on dividends and interest with tax treaty rates. Additionally, the Government has clarified that the obligation to pay advance tax on dividends will only arise on and after the declaration of such dividend.

Notably, the Government has again tinkered with TDS provisions. A new TDS obligation has been cast on buyers (with gross receipts exceeding INR 10 crores) to deduct tax on any purchase of goods exceeding INR 50 lacs. Moreover, deductors have now been saddled with the responsibility to check if the deductee has been in compliance with its tax return filing obligations for past two years. In case the deductee has failed to file such tax return, tax has to be withheld at higher rates.

Similar provision has also been introduced for tax collected at source provisions. Such provision not apply to non-residents who do not have a permanent establishment in India. It will be interesting to see if deductors will now seek proof of return filing from the deductee as a part of their diligence before withholding applicable tax.

It’s safe to say that Union Budget 2021 continues with the existing tax structure on an “as is where is basis”, and deviates only for a little detox

Amit Singhania and Gouri Puri are Tax Partners at Shardul Amarchand Mangaldas