FEBRUARY 06, 2020

By Samir Parekh, Kunal Desai and Hema Mamgai

IN the midst of a slowing economy and widening fiscal deficit, there was hope that the Hon'ble Finance Minister would provide relief to non-resident taxpayers in the financial services sectors, in order to boost investment and revive the economy. Accordingly, the Finance Bill, 2020 tabled by the Hon'ble Finance Minister on 1 February 2020 was expected to be a balancing act between delivering on some of the pre-Budget expectations and keeping a tab on the growing fiscal deficit.

We have discussed below the key income tax highlights and provided an overview of the proposed amendments introduced in relation to taxation of non-residents in the financial services sector:

- Removal of Dividend Distribution Tax (DDT)

The Finance Bill proposes to abolish DDT and accordingly, dividend may now be taxable in the hands of the shareholders. Consequently, the dividend distributed shall be subject to withholding tax.

This should provide significant relief to non-resident taxpayers who shall now be able to claim lower rate of tax on the dividend available to them under the domestic tax law as well as respective tax treaties and claim the credit of taxes paid in India on dividend income in their home country. The Indian company distributing dividend, however, would need to undertake appropriate withholding of tax.

However, the eligibility to claim relief under respective tax treaties may need to be examined on a case-to-case basis depending upon non-applicability of the General Anti-Avoidance Rule (GAAR), Principle Purpose Test introduced through the Multilateral Instrument and beneficial ownership test for dividend under the respective tax treaties. 

-  Exemption to Sovereign Wealth Funds

The Finance Bill proposes to provide exemption for any income in the nature of dividend, interest or long-term capital gains earned by a specified Sovereign Wealth Fund investing in a company or enterprise carrying on the business of developing, or operating and maintaining, or developing, operating or maintaining any infrastructure facility, if the investment is made on or before 31 March 2024 and is held for at least three years.

This should give impetus to infrastructure development projects, one of the prime focus of the current government.

- Extension of concessional tax rate on interest income

The concessional tax rate of 5 percent available to non-resident taxpayers on interest income earned from specified investments has been extended from 30 June 2020 to 30 June 2023.

Further, the said concessional rate has also been extended to investment in municipal bonds by Foreign Portfolio Investors (FPI) and Qualified Foreign Investors, made on or after 1 April 2020

- International Financial Services Centre (IFSC)

To promote listing of bonds on the IFSC stock exchange, the Finance Bill proposes to further reduce the above referred concessional tax rate on interest from 5 to 4 percent, in respect of interest paid on monies borrowed in foreign currency from a source outside India by way of issuance of any long-term bonds or rupee denominated bonds listed on the stock exchange located in any IFSC and issued on or after 1 April 2020 but up to 30 June 2023.

- Rationalisation of indirect transfer tax provisions

The FPI regulations were amended by the Securities and Exchange Board of India last year wherein the category of FPIs were reduced to two from earlier three. Accordingly, the Finance Bill proposes to rationalise the provisions of indirect transfer tax to now exclude only Category I FPIs from the ambit of indirect transfer tax.

- Thin capitalisation rule to not apply for loan provided by PE of foreign banks

The Finance Bill, 2020 proposes to amend the thin capitalisation rules to provide that the interest limitations will not apply to interest paid in respect of a debt issued by the Indian branch of a foreign bank.

- Sunset clause for Special Economic Zone (SEZ) not extended

The sunset clause for SEZ ending on 31 March 2020 has not been extended. An extension was an industry request. The existing units may however be eligible for direct tax exemptions till the unexpired period

- Relaxation from filing of tax return

Foreign entities earning income in the nature of dividend and interest which are subject to tax in India on gross basis under section 115A, would be exempted from filing the income tax return if tax has been deducted as per the provisions of section 115A of the Act. The said exemption may not apply if treaty relief is claimed.

- Transfer Pricing amendment

The Finance Bill proposes to expand the scope of the Advance Pricing Agreement provisions to include determination of profit attributable to a Permanent Establishment (PE). The benefit of the rollback can also be availed by such PEs.

The Finance Bill also proposes to expand the scope of safe harbor rules to cover profits attributable to a PE.

- Litigation related proposal

The provisions for reference to Dispute Resolution Panel (DRP) before passing the final assessment order to also apply to a non-resident not being a company. Further, the reference can be made to DRP if there is a variance of income or loss and also in case of other variances.

The Finance Bill also propose to amend the powers of the Income-tax Appellate Tribunal to grant stay and extension thereof subject to the taxpayer depositing not less than 20 percent of the amount of tax, interest, fee, penalty, or any other sum payable under the provisions of the Act; or furnishing security of equal amount in respect thereof.

Conclusion

The proposal to remove DDT, extension of concessional rate of tax on interest earned by non-residents and exemption of income earned by Sovereign Wealth Funds demonstrates focus of the government to cater to the needs of foreign investing community.

The relaxation from filing of the income tax return would also provide considerable ease to non-resident taxpayers.

However, the expectation to reinstate long-term capital gains tax exemption has not been considered. The government thus has indicated that the capital gains tax is here to stay.

The government has also been quite aggressive in rationalising the corporate tax rate which has been welcomed. However, the corporate tax rate for foreign companies not subjected to specific relief, is still at 40 percent (plus applicable surcharge and cess). Although not addressed in the current Budget proposal, a rationalisation of the tax rate for non-resident taxpayers is now in order.

[Samir Parekh is Director, Kunal Desai is Manager, and Hema Mamgai is Assistant Manager with Deloitte Haskins and Sells LLP. The views expressed are strictly personal.]