In the DTC, it is stipulated that non-residents would be subject to tax on capital gains arising from the disposal of capital assets situated in India. The Code, inter alia, provides that share of a company registered or incorporated outside India shall be deemed to be situated in India if such share derives its value substantially from the assets located in India. By virtue of such deeming fiction, the law presumes that the underlying objective behind transfer of such share is nothing but to indirectly transfer the assets located in India. Hence, such indirect transfer is liable to be taxed in India on a proportionate basis.
In the earlier version of DTC, it was provided that to trigger such deeming fiction, at least 50% of the Fair Market Value (FMV) of global assets, owned by the foreign company, should be located in India. The revised DTC has lowered the 50% threshold limit considering it to be too high to the following situations:
n at least 20% of the FMV of all assets owned should be located in India
*FMV of Indian assets exceeds the prescribed amount.
Thus, the scope of deeming fiction has been enlarged. The revised provision now has two limbs. Under the first limb, the proportion of FMV of the Indian assets as compared to FMV of the global assets of a company has been reduced from 50% to 20%. The second limb is intended to tap high value transactions if FMV of the Indian assets exceed the prescribed limit even though the percentage may be less than 20%. The recommendation of the expert committee under the chairmanship of Parthasarathi Shome to tax gains from transfer of shares in foreign companies only if the shares derived more than 50% of their value from the assets located in India has not been accepted in the DTC.
As a result of revised provision, there would be many transactions falling under the ambit of capital gains tax in India which undoubtedly would increase tax burden on non-residents. However, for small shareholders, there is a sigh of relief as the Code exempts levy of capital gains tax arising out of indirect transfer when their stake in the Indian company does not exceed 5%.
The Government, vide Finance Act, 2012, brought in retrospective amendments in the present Act, which overruled the decision rendered by Supreme Court in Vodafones case, indicating that it was always the intent of the legislature to tax such transactions where the share derives its value substantially from the assets located in India. The present statute neither provides any threshold for the meaning of the phrase derives, directly or indirectly, its value substantially from the assets located in India, nor specifies to what extent such gain would be taxable in India.
The fate of DTC will depend on the policies and priorities of the next government. It would be interesting to wait and watch how the proposed threshold limit of 20% is brought into legislation by the government.
Another new provision is the levy of Branch Profit tax (BPT) on foreign companies having permanent establishment (PE) or immovable property in India. Conceptually, the BPT provision is similar to dividend distribution tax without having linkage with repatriation of income. The DTC, compared to the provisions of the I-T Act, reduces corporate income tax rate for foreign companies from 40% to 30% which is in line with the tax rate of domestic companies. In addition to the income tax payable by foreign companies, BPT would be levied at the rate of 15% on total income as reduced by income tax payable on such income in India. Accordingly, the effective tax rate for foreign companies would be 40.5%. The important aspect to note is that tax treaty protection does not apply on this levy. DTC also provides that the liability of the foreign company arising on account of BPT cannot be treated as discriminatory. The definition of PE under DTC is much wider in comparison to definition in tax treaties. It is believed that the non-applicability of treaty provisions on such levy can lead to serious ramifications.
One of the key areas of concern could be that the foreign companies exempt from paying taxes in India under the tax-treaty (such as those engaged in shipping, air transport, etc) may now come under the ambit of taxation owing to BPT provisions.
It is evident that the aforesaid new provisions in DTC would widen the tax base and would certainly meet one of the primary objectives of introducing the new Code. Having said so, it also needs to be considered that widening the tax base by expanding Indias taxing power over foreign companies would also have an impact on Indias dream of receiving foreign investments. One may hope that government would correctly ascertain the utility of such provisions keeping in mind the overall economic needs of our country and strike a balance between the two.
With inputs from Amit Patni, senior manager, tax & regulatory services, PwC India
The author is associate director, tax & regulatory services, PwC India. Views are personal