Finance Bill 2017 will have a far-reaching impact on transaction activity in India as well as go a long way in the way India Inc has been used to set up corporate structures. Signalling that the government is focused on fundamentals-led growth without the need to get populist, some of these measures are well-positioned to expand the tax base and support investment in the economy. At the same time, finance minister Arun Jaitley has shown a clear intent to reduce ambiguities and provide greater clarity on some transactions which have been a centre of litigation for a long time now.
A clear code has been proposed to tax joint development agreements with an area share. It is now proposed to defer the point of taxation to the year in which completion certificate for the project is received. Valuation for determination of the consideration is linked to the prevalent circle rate. This provision promises to set to rest the widespread litigation that has impacted the real estate sector and its deal-making activity over the past many years. Another substantial amendment is on the long-term capital gains exemption on listed shares, which has now been made conditional upon the original purchase transaction being subject to securities transaction tax. This is important as it impacts companies which have been listed in the past few years. This is also likely to impact returns of private equity investors and promoters’ ability to monetise their holding.
Further, the way the new section is drafted leads to a differential treatment between growth-funding and secondary-sale transactions as it potentially seeks to deny exemption to the former in case of select companies. The CBDT’s draft notification seeks to provide clarity on transactions which will continue to enjoy the exemption. However, whether various forms of off-market purchases of shares of listed companies will be eligible for the exemption could become a matter of debate and dispute in times to come. Perhaps, it will be useful to examine the draft in light of the stated intentions of the ministry in the Memorandum to Finance Act as well as the press release of CBDT.
In parallel, transactions involving transfer of shares of unlisted companies have now been made subject to minimum valuation norms based on fair market value, along the lines of existing provisions for immovable property. Coupled with existing provisions for valuation of fresh issue of shares in unlisted companies, it appears that the government wants to track down transactions involving unlisted companies, especially those which are done as part of an internal group restructuring. Interestingly, the language of the amendment here also poses doubts on whether the amendment covers only unlisted shares or also shares of listed companies which are not frequently traded on the stock exchanges.
It is possible that the rules for valuation under these provisions may not be along the existing lines under Rule 11UA which essentially uses book value as the valuation basis. Further, the insertion of this provision also potentially might lead to double taxation on the seller as well as the recipient when the transfer is done at a lower valuation, since the recipient is subject to tax on receipt of these shares for inadequate consideration.
The Budget also made some important amendments which are seen to adversely impact succession planning efforts by Indian promoters. Over the past many years, family trusts have emerged as one of the preferred ways of planning inheritance and safeguarding wealth, purely on account of the flexibility such trusts provide in managing succession in its form as well as proportion. Purely from a tax perspective, this Budget has a reason for concern for such structures. A significant change impacting family trusts is the expansion of the taxability of gift transactions in the hands of the recipient. The new section 56 increases the scope as well as coverage of gift transactions, and hence, settlement of properties into family trusts may henceforth invoke the provisions of this section. One exception to the applicability of this provision has been provided where trust receives property from an individual for the sole benefit of the relative of the individual.
Again, there are a multitude of options and possibilities which arise as a result of this change, and it will be interesting to see the evolution of family trust models in future. Expanding the cover of the dividend tax in the hands of the recipient, the amendment now covers all categories of recipient assesses with a select few exceptions such as companies and charitable trusts. While there could be technical arguments against the coverage of private discretionary trusts within this definition, this is likely to be one of those provisions witnessing significant action in future.
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From a foreign investment perspective, this budget has some path-breaking provisions. While the abolition of the Foreign Investment Promotion Board and exemption from indirect transfer provisions to category I and II foreign portfolio investors certainly are very positive announcements, the introduction of thin capitalisation norms is a bold move reflecting India’s commitment to the BEPS project of OECD. These norms limit the deductibility of interest to 30% of EBITDA of the Indian company and are likely to impact MNCs that fund their Indian subsidiaries more by way of debt instruments permitted under the FDI route. The other class of companies which may witness turbulence due to this move is real estate companies which have seen investments by private equity investors through a combination of low equity and higher debt in the form of compulsorily convertible debentures or listed non-convertible debentures.
The above changes come with a corresponding reduction in tax rates for low income individuals as well as small and medium enterprises. Clearly, the Budget has been drawn with the objective to boost economic growth, attract foreign investments while passing on the benefits of demonetisation to the lower strata. The focus on long-term growth remains the buzzword in line with the government’s other policy efforts over the last few years now.
Vaihav Gupta & Saumdra Acharyya
Vaibhav is associate partner and Samudra is principal at Dhruva Advisors LLP. Views are personal.