Photo of S.R. Patnaik

Head and Partner in the Tax Practice at New Delhi office of Cyril Amarchand Mangaldas. Mr. Patnaik specialises in various aspects of direct tax, such as international tax, transfer pricing, corporate tax etc. He can be reached at sr.patnaik@cyrilshroff.com

One of the most widely litigated issues in India is the disallowance of expenditure incurred on earning income that is exempt from tax. In an endeavor to put the controversy to rest, the Supreme Court (“SC”) in the recent case of Godrej & Boyce Manufacturing Company Ltd. v. DCIT,[1] has held that expenditure should be disallowed if it is incurred in connection with the earning of tax-exempt income.

Facts

Godrej & Boyce Manufacturing Company Limited (“Taxpayer”) is engaged in the business of manufacture of steel furniture, electrical equipments, etc. It is also a promoter of various other companies and invests funds into these companies to maintain control over them.

Continue Reading Clearing the Air: SC Confirms Disallowance of Expenses Pertaining to Exempt Income

With globalisation spreading economic activities across jurisdictions, enterprises nowadays have a presence in several jurisdictions. The taxability of activities undertaken by companies on foreign soil is closely linked to whether they are conducted through a permanent establishment (PE). This is a concept widely used in the context of international taxation wherein a particular business transaction leaves its footprint in multiple jurisdictions. Under the terms of various tax treaties, existence of a PE in the source State is a pre-requisite to hold a non-resident liable to pay taxes on business profits. The term PE is generally defined in the tax treaties as “a fixed place of business through which the business of a foreign enterprise is carried on wholly or in part”.

Under the various tax treaties executed with other countries, India imposes tax on any business income accruing or arising to a non-resident, whether directly or indirectly through or from any PE in India.

Continue Reading Formula One: SC Lays Down the Formula for Permanent Establishment

Indian income tax law exempts long-term capital gains arising from transfer of listed equity shares provided such transfer takes place through the stock exchange, and securities transaction tax (STT) is paid. However, the Government believes that this exemption is being misused by certain unscrupulous elements to convert unaccounted money into legal money. The law was therefore recently amended to remedy the situation, restricting this benefit only to such cases where STT is paid both at the time of purchase as well as sale.

However, since this amendment is being introduced as an anti-abuse provision, it also provided that the Government would notify certain types of acquisitions where this restrictive provision would not apply so that genuine business transactions are not impacted.

A draft notification has recently been issued by the Central Board of Direct Taxes (CBDT) attempting to list out such instances and inviting comments from stakeholders. Through this blogpost, we will discuss the efficacy and appropriateness of this draft notification.

Draft CBDT Notification

As discussed above, the recent amendment provides that the capital gains exemption shall be available only in such cases where STT is paid both at the time of purchase as well as at the sale of such listed shares, unless the shares were acquired through a mechanism which has specifically been notified to be unaffected by this provision. In other words, the import of this provision is very wide and could deny capital gains exemption to all such instances unless the notification exempts them. To protect genuine business transactions, the Government has been empowered to come up with instances where the exemption will not be denied. Hence, the nature of transactions to be specified by the notification shall be very important to determine the taxability of capital gains.

Continue Reading Draft CBDT Notification on Withdrawal of Capital Gains Exemption – Clearing the Maze or Further Compounding it

The Finance Bill 2017 proposes certain significant amendments in respect of the direct tax regime, especially in the area of M&A and restructuring / reorganisation. While some of the suggested changes are designed to ensure that the provisions are not abused by taxpayers through aggressive tax planning, the Finance Bill also attempts to provide much needed clarity on certain long-standing issues. This blog post briefly deals with some of the key points regarding restructuring / reorganisation and M&A transactions. Continue Reading M&A and Internal Restructuring – Providing Clarity & Plugging Loopholes

India has time and again shown its commitment to curbing base erosion and profit shifting (BEPS), an initiative of the Organisation of Economic Co-operation and Development (OECD) and the G20 nations. The Finance Act 2016 is testimony to this fact as it enabled the introduction of an equalisation levy, country-by-country reporting and the Indian patent box regime. The Government has been continuously revising various tax treaties to plug loopholes, strengthen information sharing between the contracting states and prevent double non-taxation under the garb of avoidance of double taxation.

In continuation of the Government’s support of the BEPS project, the Finance Bill 2017 proposes to introduce measures to curb thin capitalisation in India. Continue Reading Thin Capitalisation – The Line Is Getting Blurred!

Putting to rest the speculation surrounding the Double Taxation Avoidance Agreement (DTAA) with Singapore, the Government of India has finally announced that it has been revised. This announcement was made on December 30, 2016, and the text of the new protocol amending the India-Singapore DTAA (Protocol) has since been made available. The Protocol is along expected lines on the taxation of capital gains front. But, surprisingly, it has not granted incentives on taxation of interest income and Singapore based investors would be at a significant disadvantage as compared to Mauritius based investors.

KEY REVISIONS TO THE DTAA
Continue Reading India-Singapore DTAA Meets the Same Fate as Mauritius & Cyprus

India and Cyprus have recently revised the Double Taxation Avoidance Agreement (DTAA) to be effective from April 01, 2017 and January 01, 2017 in India and Cyprus respectively.

Before 2013, Cyprus was a favoured jurisdiction for investments into India as capital gains from the sale of shares held by Cyprus based investors in Indian companies was not taxable in India. However, due to non-compliance of its information sharing obligations, India declared Cyprus a Notified Jurisdictional Area (NJA). This led to significant uncertainties. While the DTAA had not been rescinded, this development resulted in adverse implications for Cyprus based investors, including, inter alia, higher rate of withholding taxes, application of transfer pricing provisions to transactions with Cyprus based entities even though they are not related, etc. Thus, conducting regular business transactions between entities of both countries became difficult with many transactions getting deferred.

The revised DTAA is the culmination of prolonged negotiations and discussions between both the countries to address this situation. Pursuant to the execution of the revised DTAA, the notification declaring Cyprus as NJA has been rescinded. Continue Reading Revision of the India-Cyprus DTAA: On Expected Lines

Long years of negotiations with Mauritius have finally culminated in the signing of the Protocol amending the Convention between Government of Mauritius and the Government of Republic of India (GOI) on May 10, 2016 (Protocol). This has resulted in a complete overhaul of the India – Mauritius Double Taxation Avoidance Agreement (DTAA).

A Few Key Changes

While the DTAA granted taxation rights on capital gains (CG) only to Mauritius and in the context of Mauritius entity’s alienation of shares in an Indian company, the Protocol has reversed the position and allows India the right to tax such CG in respect of shares acquired on or after April 1, 2017. Further, the CG realised by Mauritius entities from April 1, 2017 to March 31, 2019 (Transition Period) would be taxable at a concessional rate of 50% of the applicable tax rate in India. This concession would be subject to the satisfaction of certain conditions under the newly inserted limitation of benefits (LOB) clause. Interestingly, the LOB relies on the concepts of ‘primary purpose’ and ‘bonafide business activities’ which are undefined terms. As such, this may result in interpretation inconsistencies and maybe litigation.

Prior to the Protocol, interest income (II) earned by Mauritius entities was taxable at high rates under Indian tax law.  As such, investments from Mauritius were not structured as debt or convertible debt on account of the high tax incidence on II. However, Mauritius based banks were exempt from taxation of II. The Protocol now restricts the tax payable in India on interest payable to all Mauritius incorporated entities (including banks) at a mere 7.5% of the gross amount of II by borrowers based in India, provided the Mauritius entity is the beneficial owner. Thus, the Protocol allows Mauritius based entities the most favourable tax treatment of II among all the tax treaties that India has signed so far.

Other significant amendments include the provision for establishment of service permanent establishment in the definition of permanent establishment and introducing tax on payments made to a Mauritian entity towards fees for technical services. Similarly, the Protocol also tries to tax all types of income as ‘other income’ which have not been specifically addressed in the various articles of the DTAA. The Protocol also introduces additional enabling provisions to facilitate exchange of information and assistance in collection of taxes.

What Does this Mean for Indian Investments?

The Protocol is expected to change the nature and volume of foreign investments coming to India through Mauritius. Strategic investments, given the longevity and nature of the investment and given that taxation will be factored into the investment decision, may not be significantly impacted as they could come directly into India (instead of being routed through Mauritius). However, short term financial investments such as private equity and venture capital investments (made mostly in unlisted companies) could be affected, at least in the short term, due to a fall in the rate of return on account of taxes. FPI investments with an over-12 months holding period should not be impacted. However, CG earned by Mauritius based FPIs on investments held for less than 12 months would now be subject to CG tax and thus, could see a downturn. Further, participatory notes issued by FPIs could become less attractive to investors as FPIs will seek to shift their tax burden.

The reduced tax rate of 7.5% on II could lead to a surge in debt related investments from Mauritius.

Further, the Protocol only levies tax on CG arising from the transfer of shares in India. To that degree, it may be contended that CG earned from the transfer of other instruments (e.g. compulsorily convertible debentures or non-convertible debentures) may be exempt from tax in India as per the provisions of the DTAA. However, statements issued by senior revenue authorities immediately after the signing of the Protocol suggest that all types of CG arising to a Mauritius based investor will now be taxed in India.

Some Key Takeaways

The grandfathering of acquisitions made before March 31, 2017 and the concessional rate of tax for the transitional period provide investors with adequate advance notice of the change in law. This evidences the GOI’s commitment towards a stable and predictable tax regime. Further, the interplay between India’s General Anti Avoidance Rules (proposed to be made effective April 1, 2017) and LOB provisions will be interesting, as the former also allows Indian tax authorities to deny treaty benefits. .

The Protocol would also trigger renegotiation of the India-Singapore DTAA since the beneficial provision for taxation of certain CG (e.g. on shares) only in the state of residence in the India-Singapore DTAA is coterminous with similar provisions in the India-Mauritius DTAA. This would also have been the case with Cyprus but post it’s blacklisting by the GOI for lack of effective exchange of information, Cyprus is anyways no longer considered favourably by investors looking to invest into India.

One will have to wait and watch India would revise similar provisions in the DTAA with the Netherlands. In case the same is not renegotiated, there may be a significant surge in investments into India through the Netherlands.

It is evident that India wants to eventually phase out the preferential tax treatments given to various jurisdictions under the respective tax treaties so that the investors are encouraged to invest directly from their own home jurisdiction. The Protocol seems to be first step in this direction and eventually, it appears that all DTAAs granting similar tax benefits would be renegotiated.

In any case, as far as Mauritius is concerned, given the Protocol, it would no longer be tax viable for investors who, without having any substantive presence in Mauritius, were routing their investments through Mauritius.