INSIGHT: India Union Budget—Key Tax Proposals for International Investors

India’s new finance minister announced the union budget for 2019 on July 5, 2019, with an ambitious vision to become a $5 trillion economy in the next few years. India is now the sixth largest economy in the world (third in purchasing power parity terms) and is expected to become a $3 trillion economy in the current financial year.

Key Developments Prior to the Union Budget

On June 25, 2019, shortly before the announcement of the union budget, India deposited its instrument of ratification of the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). The MLI will be effective as from October 1, 2019 for India and the changes to India’s tax treaties are likely to be effective for India from April 1, 2020 where India’s treaty partner has also deposited its instrument of ratification.

In April 2019, India’s Central Board of Direct Taxes issued a public consultation document on proposed changes to rules for the attribution of profits to a permanent establishment (PE) in India. The draft proposes a shift from the functions asset risk approach to a three-factor-based approach—using sales, assets, and manpower for attributing profits to an Indian PE. In respect of digital businesses, the draft suggests adding “users” as a fourth factor for profit attribution.

Key Tax Proposals in the Union Budget

Rationalization of Corporate Tax Rate

The finance minister is continuing with the phased rationalization of the headline corporate tax rate of 30%. For financial year (FY) 2019–20, the reduced corporate tax rate of 25% (plus a surcharge and cess) would apply to Indian companies whose FY 2017-18 turnover did not exceed 4 billion Indian rupees ($58 million) (increased from FY 2016-17 turnover of 2.5 billion rupees for applying the reduced corporate tax rate of 25% for FY 2018-19).

With the proposed change, 99.3% of Indian companies would be eligible for the 25% rate.

Tax Incentives for International Financial Services Center

The budget contains several tax proposals to incentivize the financial industry to move to the International Financial Services Center (IFSC) established in Gujarat, including:

• a 100% profit-linked deduction for 10 years (currently, a 100% deduction is available for the first five years, reducing to 50% for the next five years);
• an extension of the exemption from dividend distribution tax to dividends paid out of past profits;
• a tax exemption for interest income arising to a nonresident from monies lent to a unit located in the IFSC; and
• an extension of the tax exemption for capital gains on specified securities to Category III alternative investment funds.

Secondary Adjustments for Transfer Pricing Purposes

Taxpayers were facing secondary adjustments if they failed to repatriate cash into India following a primary adjustment to the transfer price. A proposed budget measure would allow taxpayers the option to pay one-time additional tax of 18% on the excess cash (or part thereof), where the cash is not repatriated to India within the prescribed time limit. Notional interest under the secondary adjustment would not apply from the date of payment of the additional tax but the taxpayer would not be entitled to a tax credit or deduction for the additional tax paid.

Other Highlights

• Announcement of an investment-linked income tax exemption for establishing “mega” manufacturing plants in sunrise and advanced technology areas (e.g. semi-conductor fabrication, solar photovoltaic cells, lithium storage batteries, solar electric charging infrastructure, computer servers, laptops, etc.);
• A proposal to levy tax on the “super-rich” that would increase the effective tax rate for individuals, trusts and other non-corporates (excluding partnerships) from 35.88% to 39% where income is between 20–50 million Indian rupees, and to 42.74% where the income exceeds 50 million rupees;
• The buyback tax (payable by a company on profits distributed to shareholders by way of a buyback of shares) would be extended to apply to listed shares as from July 5, 2019;
• A measure will be introduced to confirm that every constituent entity of a multinational group would be required to submit a master file for transfer pricing purposes even where there are no cross-border transactions undertaken by that constituent entity;
• Rules will be introduced to encourage digital payments and discourage cash withdrawals by requiring all businesses with total turnover or gross business receipts exceeding 500 million Indian rupees to provide a facility for accepting electronic payments or be subject to a penalty. A 2% withholding tax would be imposed on total cash withdrawals exceeding 10 million Indian rupees per bank account per fiscal year ending March 31; and
• Relaxations in the foreign investment rules for the single brand retail, aviation, insurance, insurance intermediaries, and media sectors.

The Way Ahead

Following the government’s overhaul of the indirect tax system in India with the implementation of Goods and Services Tax, it now is the turn of the direct tax system. The existing law governing direct taxes—the Income-tax Act, 1961—was drafted 60 years ago and has undergone numerous updates to keep up with the changing realities of business and the economy.

The government is close to implementing the Direct Tax Code to replace the Income-tax Act, 1961 and the task force appointed to draft the code will present that draft to the government on July 31, 2019.

Significant tax developments, therefore, can be expected in 2019 beyond those announced in the recent budget.

Pritin Kumar is a Partner and Vishal Palwe is a Senior Manager with Deloitte Haskins & Sells LLP, India.

The authors may be contacted at: pkumar@deloitte.com; vpalwe@deloitte.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.