1. Retrospective tax: Many Budget 2017 proposals may have adverse retrospective impact on taxpayers

Retrospective tax: Many Budget 2017 proposals may have adverse retrospective impact on taxpayers

Budget 2017 was unique in many ways. Adding to the uniqueness are the many tax proposals which have been retrospectively amended, but in favour of the taxpayer.

By: | New Delhi | Published: February 9, 2017 5:08 AM
It may be recalled that a press release on October 29, 2015, clarified that 5% TDS would apply to these bonds. However, this did not have the force of law until the present amendment. (PTI) It may be recalled that a press release on October 29, 2015, clarified that 5% TDS would apply to these bonds. However, this did not have the force of law until the present amendment. (PTI)

Budget 2017 was unique in many ways. Adding to the uniqueness are the many tax proposals which have been retrospectively amended, but in favour of the taxpayer. A case in point is the extension of benefit of the 5% withholding tax (TDS) rate on rupee-denominated bonds (masala bonds) with retrospective effect from FY16 onwards. It may be recalled that a press release on October 29, 2015, clarified that 5% TDS would apply to these bonds. However, this did not have the force of law until the present amendment.

However, the other unique feature, which has perhaps not received sufficient attention, is that there are some very far-reaching tax amendments, which ostensibly appear prospective, but have a material and adverse retrospective impact on taxpayers.

Long-term capital gains (LTCG) exemption curtailed based on acquisition criteria: At present, LTCG arising on transfer of equity shares in a company or a unit of an equity-oriented fund is exempt from tax, if the sale transaction suffers Securities Transaction Tax (STT). It is now proposed that this exemption would no longer be available if the shares or units were acquired after October 1, 2004, and no STT was paid at the time of acquisition. Though this provision applies for sale transactions taking place prospectively from April 1, 2017, putting such an onerous condition now on the acquisition transaction is makes it both retrospective and harsh. This has an unfair adverse consequence of making taxpayers pay tax simply because their acquisition transaction did not require them to pay STT, and more so, because at the time of the acquisition there was no such condition! To illustrate the breadth of impact that this can have, even employees who have obtained shares when they were unlisted under an employee stock option scheme will no longer enjoy the exemption.

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This sweeping curtailment will adversely impact several genuine taxpayers. A notification is expected carving out certain exceptions like IPOs, FPOs, bonus or rights issues, acquisition by non-residents under the FDI policy, etc. While no doubt the carve-outs will be necessary, it would be good if the amendment is truly prospective by applying this condition only to acquisitions made from April 1, 2017.

Introduction of secondary adjustments applies for primary adjustments already made in FY17: Secondary adjustments seek to give an economic effect to the primary transfer pricing adjustment as if the underlying transaction had actually taken place at arm’s length. Many jurisdictions provide for secondary adjustments in the form of a deemed dividend, equity contribution or loan.

The provisions define a secondary adjustment as an adjustment in the books of accounts of the taxpayer and the associated enterprise (AE). Further, there is a requirement to repatriate the excess money available with the AE to India. If such excess money is not repatriated within the prescribed time limit, the same will be considered as an advance made by the taxpayer to the AE, and interest will be computed on the same.

While the reservations on the necessity to compulsorily repatriate excess money in all cases is a separate matter, what is inconsiderate is that the provision applies to primary adjustments that may have already been made in FY17 that exceed ?10 million. It would have only been fair if primary adjustments made prospectively were covered under this provision.

Restrictions on interest deductions—no time to rework capital structures

As India’s response to the Base Erosion and Profit Shifting (BEPS) Action Plan 4 of the Organisation for Economic Co-operation and Development (OECD), there is a proposal to limit tax deduction of specified interest expenses effective from April 1, 2017.

Any interest paid above ?10 million in excess of 30% of the EBITDA will be treated as excess interest. Excess interest disallowed in a year is however, eligible for carry forward up to eight consecutive years subject to the above limits.

OECD BEPS Report on Action 4 also recognised that any rule to limit tax deductions for an entity’s interest expense could involve a significant cost for some entities. Therefore, it expected that a country introducing a fixed ratio rule would give entities reasonable time to restructure existing financing arrangements before the rules come into effect.

However, no such time has been provided and this rule applies immediately with effect from April 1, 2017. Additionally, some leeway should be provided to sectors such as infrastructure and real estate that are by nature financed mostly by debt.

It has been the stated policy of this government to not pursue a policy of retrospective amendments; yet, as has been illustrated above—and equally as has been done in earlier Budgets too—a backdoor manner of achieving the same retrospective application does not augur well for the overall theme of reducing uncertainty and increasing the ease of doing business.

With contributions from Cynthia D’Almeida,director (tax).

The author is partner (tax & regulatory), PwC.

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