By Hiten Kotak & Hemal Uchat
Union Budget 2020 India: With the economic slowdown at our door, the Budget tries to fuel the engines of growth through a paradigm shift in governance, to imbue the world’s fifth largest economy with flavours of aspiration, economic development, and care. The Budget has possibly used all likely measures to give the economy a shot in the arm. Given the fiscal deficit of 3.8% of GDP in FY20 (with sliding tax collections ), the ambitious disinvestment target of Rs 2.1 lakh crore through LIC and PSU banks is commendable.
The rupee coming in will go a long way in building infrastructure and logistics for India, with renewed focus on tackling unemployment.
Foreign direct investment (FDI) is a huge boost to any country; it reflects investor confidence in a country’s growth and vision, bringing in long-term capital, an essential to invigorate any economy. As per a UN report, in FY19, India received $49 bn worth of FDI, a 16% increase over the previous year. DPIIT statistics show that from April to September 2019, the inflows have been about $26 bn. While much has been done to encourage inflows, the following Budget proposals should bring cheer to foreign investors.
Abolishing Dividend Distribution Tax (DDT)
DDT has been the bane of every foreign investor looking to repatriate profits from India, primarily because of the economic double taxation. The tax of 20.56% on every rupee of dividend distributed, irrespective of the shareholder’s country and status, results in lower availability of distributable surplus for a foreign investor. As DDT is a tax on the Indian company and not on the shareholder, the final nail in the coffin is the denial of credit for such DDT by the investor’s home country.
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This Budget is all set to change this—DDT is being abolished, with India moving to the conventional system of taxing dividends in the shareholder’s hands. Indian shareholders will be taxed at applicable rates (which could be as high as 42.7%, including surcharge and cess) while foreign shareholders will be taxed at a lower rate of 20% (under domestic law) or as per the relevant tax treaty. Since most Indian tax treaties tax dividends at a beneficial 5%-15%, clearly, this puts foreign investors at an advantage over domestic investors.
The foreign shareholder may potentially now claim credit against its tax liability in its home country. However, several countries no longer tax foreign sourced dividends, making it difficult for the shareholder to offset taxes paid in India against its home country tax liability.
Cascading effect will be eliminated—dividend income will be exempt in the hands of an Indian company to the extent it itself declares dividends. If, however, it does not declare dividends, it will be taxed under normal or Minimum Alternate Tax, depending on the tax regime opted for.
A reason to celebrate, indeed, for any multinational—this, combined with reduced tax rates, is a bounty, as any repatriation from April 1, 2020, will have a lowered tax cost of 10%–15%.
Tax exemption for investments by sovereign wealth funds (SWF)
To boost sentiments of SWFs, which play an important role in developing a country’s real sector, the Budget proposes an exemption from their income (dividends, interest and capital gains) if they invest (debt or equity) into a company (for atleast three years) which develops, operates, or maintains an infrastructure facility by March 31, 2024. This should attract investment in this beleaguered sector; currently, it is not clear if only fresh investments would be eligible, or even secondary transactions.
Tax on funds borrowed from overseas
As an additional measure to attract foreign capital, the concessional withholding tax rate (WHT) at 5% is extended to interest on funds borrowed from overseas before July 1, 2023. Further, a concessional WHT of 4% has been prescribed on interest on foreign currency long-term bonds or rupee-denominated bonds (RDB), listed on a recognised stock exchange in any International Finances Services Centre, if issued between April 1, 2020, and July 1, 2023.
Similarly, WHT of 5% on interest on government securities and RDBs to FIIs and QFIs has been extended to interest payable by July 1, 2023. The concessional WHT now covers interest payable between April 1, 2020 and July 1, 2023, on municipal bonds.
These provisions provide a stable regime for overseas borrowings, and seek to keep pace with the various avenues opened by India for procuring overseas funding.
Investing into REIT and InvIT
Probably the only amendment which generates mixed feelings relates to distributions by Real Estate Investment Trusts (REITs)/Infrastructure Investment Trusts (InvITs). Just when one thought that REITs and InvITs would gain popularity, the Budget has thrown a spanner in the works.
Presently, REITs/ InvITs are largely pass-through, i.e., with exemption from DDT, profits traverse to the unit holder from the project companies as dividends without any tax. Now, the unit holder will be taxed on the distributions received from the REIT/ InvIT as dividends.
This is a dampener for the investor community and especially the fund-starved infrastructure, and real estate sector—the only redeeming feature for foreign investors is that they are in a marginally better position than domestic investors, who will be taxed at higher rates. How this move affects the nascent interest in REITs/ InvITs will be seen.
Foreign investors will now get relief from filing Indian tax returns if they earn only certain types of income, on which taxes have been withheld under domestic law. The image that India is a country of protracted litigation (almost 500,000 direct tax cases pending at various appellate levels) is sought to be cleared by the introduction of Vivad se Vishwas—this would enable foreign investors to resolve long-pending tax litigation. These measures for simplification of, and building confidence in, tax law and administration, with the possible strengthening of contract law, should go a long way in creating a sustainable investment environment, giving a fillip to both GDP and growth.
Kotak is joint leader, deals & Uchat is partner, deals, PwC India (Views are personal)