INSIGHT: India’s 2019 Budget Reforms Will Impact Cross-Border Transactions

The Indian government’s proposed reforms announced in its 2019 budget are likely to have a material impact on cross-border transactions.

I. Budget Proposals on Transfer Pricing Regulations

(a) Repatriation of Money to India Under Secondary Adjustment Law:

To rationalize the secondary adjustments law (which was introduced in Finance Act of 2017) and address challenges faced by taxpayers, the budget proposal has clarified that the secondary adjustment law will apply only to Advance Pricing Agreements (APAs) signed on or after April 1, 2017. In other words, to address the unintended consequence of law on taxpayers who had an APA, particularly with rollback provisions, there will be no requirement to remit money (under secondary adjustment provisions) in line with the APA outcome.

Further, the budget has proposed for relief to pay final tax at 18% plus 12% penalties on secondary adjustments in case the money has not been repatriated back to India. The earlier provisions provided for interest until the money is brought to India. Hence, it is no longer mandatory for the Indian associated enterprise to bring back the money if an additional tax of 18% plus penalties is paid.

(b) Gifts Made to Persons Outside India

The Budget has widened the scope of the ‘income deemed to accrue or arise in India’ (Section 9) by proposing to tax gifts made by an Indian resident to non-residents. It clarifies that a gift made by a resident to a person outside India is accrued in India and hence cannot be said to be outside the purview of Indian tax. However, it clarifies that any treaty benefits or general exemptions provided in gift taxation (section 56) shall continue to exist.

(c) Offshore Fund Taxation:

The presence of offshore fund managers in India was fraught with risk of Permanent Establishment (PE), which would have possibly led to attribution of fund’s global income to be taxed in India. To encourage onshore participation of fund managers, a new law was introduced (Section 9A) in Finance Bill of 2015. In pursuance to that, Central Board of Direct Taxes (CBDT) in April 2016 announced guidance and 13 conditions as regards membership and size of the funds. Foreign funds viewed conditions as cumbersome, unwieldy and impractical. The outcome was a few takers, thereby defeating the purpose of a noble policy.

The Budget of 2019 has revisited the 2016 guidance, liberalizing the requirements. One of the conditions that the fund should have a minimum corpus at the end of the financial year. The said condition now to be examined is at the end of a period of six months from its establishment or at the end of the relevant tax year, whichever is later.

Further, the remuneration condition to fund managers now needs to be within a prescribed limit instead of complying with the arm’s length price. The Ministry of Finance is expected to seek Public Consultation for framing such limits.

(d) Changes to Incentivize International Financial Services Centre (IFSC) and Related Funding

To promote development and ease of funding, interest on offshore borrowings by IFSC shall be exempt from tax. Similarly, offshore investors in IFSC shall be exempt from Dividend Distribution Tax on their earnings. This shall apply to dividends declared on profits from April 1, 2017.

(e) Procedural Reform to File an Online Application to Determine Withholding Tax Liability on Payment to Non-residents:

With an intent to streamline the process for speedier processing of applications and effective monitoring of payments to non-residents, the budget has proposed to allow online filing of application to the Revenue for determination of withholding tax liability.

II. Other Recent Developments:

(a) Ratification of MLI by India:

The provisions of the MLI were released in late 2016 by the OECD with an object to address aggressive tax strategies by Multinational Enterprises (MNE) which exploits mismatches in domestic tax laws of countries and result in the shifting of profits to low jurisdictions. The Instrument seeks to implement a series of measures to address treaty abuse, dispute resolution, artificial avoidance of Permanent Establishment (PE).

India has shown its commitment to adopt BEPS measures by ratifying the MLI on June 25, 2019. The MLI will come into force for India on October 1, 2019, and its provisions will impact Indian tax treaties from FY 2020-21 onwards. However, India’s DTAA with those countries will not be affected if its treaty partner has not ratified MLI or if it has not been notified as Covered Tax Agreement (CTA) by India. Because the U.S. is not a signatory to the MLI, the India-U.S. tax would remain unchanged by the ratification of MLI by India. Further, while Mauritius is a signatory to the MLI, the India-Mauritius tax treaty has not been listed as a CTA by Mauritius. Till now, 89 counties have signed the Instrument out of which 29 have already ratified it.

India has expressed its position to agree to the application of Article 7(1) of the Convention dealing with Principal Purpose Test (PPT) alone as an interim measure and to adopt optional provisions of Limitations of Benefits (LOB) along with PPT through bilateral negotiations.

(b) India’s Public Consultation Proposal on Profit Attributions to PE:

CBDT released in April 2019 a public consultation document for determination of income of non-residents having a PE in India. This was in pursuance to Significant Economic Presence (SEP) law legislated in 2018. India’s existing approach for attribution of profits to PE comprises of three methods i.e. (i) the presumptive taxation method (ii) proportional method and (iii) residuary method. The attribution principles in the domestic law, besides leaving wide discretion with the tax administration is viewed as a global formulary approach.

For restricting discretionary approach of the revenue to invoke such residuary method, particularly in the absence of separate financial statements of Indian PE, India proposes to adopt a fractional apportionment method consisting of an amalgam of three-factor: sales, manpower and assets to attribute profits in the hands of a PE.

In the case of digital businesses, an additional fourth-factor ‘users’ has been added. India departs from the global formulary approach due to practical constraints on the availability of consolidated information.

It is widely perceived that the Consultation paper has departed from the Authorised OECD Approach (AOA), articulated in Article 7(2) of OECD Model which attributed profits on the basis of FAR analysis stating that the demand side factors represented by sales are not taken into consideration and placed reliance on customary approach of Article 7 (4) of the UN Model for such method. It is anticipated that either revised guidance will be circulated for debate or India will await the outcome of Digital taxation action under the inclusive framework given that India’s proposition for Pillar I (comprising of SEP and intangibles) support is gaining momentum.

(c) Implementation of General Anti Abuse Avoidance Rules (GAAR):

India introduced the General Anti Abuse Avoidance Rules (GAAR) through Finance Act, 2013 that has been effective since FY 2017-18.

Under GAAR, to declare an arrangement to be an Impermissible avoidance arrangement, the tax officer initiating GAAR proceedings needs to refer to the Approving Panel. The approving panel consisting of three members including the chairperson who has been a judge of a High Court and one member from Indian Revenue Service and one member from an academic or scholar having specialized knowledge of matters. Up until July 2019, the GAAR panel had not been formed.

While we digest the budget proposals and other recent developments, we expect that there is more to come by way of Direct Tax Code changes to rationalise the provisions in the area of international taxation.

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

By Mukesh Butani & Surekha Debata. Mukesh Butani is the founder and Managing Partner of BMR Legal Advocates and Surekha Debata is the Managing Associate at the Firm. The authors acknowledge the contribution of Bhagyashree and Saurabh Nandy, Associates.