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  • 1. Analysis ofDISCUSSION PAPER ONTHE DIRECT TAX CODE(For internal circulation only)
  • 2. Contents• MINIMUM ALTERNATE TAX• FOREIGN CO - RESIDENCY TEST• CONTROLLED FOREIGN CORP• DTAA vs DOMESTIC LAW• CAPITAL GAINS• FOREIGN INSTITUTIONAL INVESTORS• GENERAL ANTI AVOIDANCE RULES• SPECIAL ECONOMIC ZONES• INCOME FROM EMPLOYMENT• EEE vs EET• HOUSE PROPERTY• NON-PROFIT ORGANISATION• WEALTH TAX• UNADDRESSED ISSUES• ACT vs DTC vs RDTC
  • 3. MINIMUM ALTERNATE TAX (MAT)
  • 4. MINIMUM ALTERNATE TAX (MAT)  MAT to be levied on value of gross assetsProposed  MAT rate – 2 percent (0.25 percent for banking companies)  Value of ‘gross assets’ to include, inter alia, capital work-in-progress  Credit of MAT not allowable in subsequent years  Asset based MAT not linked to particular year’s income or turnover – hardship for  loss making companies  Not reasonable to apply MAT for newly set-up infrastructure companiesIssues which have  long gestation period or companies undergoing major expansion  Contradicts policy on ‘investment linked’ incentives  Cascading effect in case of multiple tiers of subsidiaries
  • 5. MINIMUM ALTERNATE TAX (MAT) (Cont)  MAT levy aligned to current regime – to be levied on ‘book profits’Revised  Rate of MAT to be decided by legislature  Rate of MAT and method of computation of book profits not yet known  Apparently the existing MAT provisions would be reinstated – litigative issuesInterpretation  under the current regime may be clarified  Provisions relating to MAT credit are yet to be prescribed, though from the plain  reading of the revised discussion paper it appears that the credit may be available  In case of foreign companies, branch profits tax may be levied over & above MAT
  • 6. FOREIGN COMPANIES
  • 7. FOREIGN COMPANIES  Foreign company to be regarded as resident, if ‘control and management ofProposed affairs’ situated ‘wholly or partly’ in India at any time during the financial year  ‘Control and management’ not defined  Word “partly’ used in the DTC sets a very low threshold for regarding a foreign company as a resident in IndiaIssues  Apprehensions expressed that it could lead to a foreign multi-national company being held as resident in India on the ground that some activity like a single meeting of the Board of Directors is held in India  ‘Place of effective management’ test prescribed for determining residence  ‘Place of effective management’ defined as:Revised “the place where the board of directors or its executive directors, make decisions; or where the board routinely approve the commercial and strategic decisions made by the executive directors or officers, the place where such executive directors or officers perform their functions
  • 8. FOREIGN COMPANIES (Cont)  Place of effective management’ would need to be determined based on facts ‘The OECD Commentary provides the following in this regard :Interpretation  “The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made. All relevant facts and circumstances must be examined to determine the place of effective management. An entity may have more than one place of management, but it can have only one place of effective management at any one time.
  • 9. CONTROLLED FINANCIAL CORPORATION
  • 10. CONTROLLED FINANCIAL CORPORATION  No explicit proposals for introducing CFC regimeProposed  Residence test for foreign company was viewed as backdoor entry for CFC regime  CFC provisions proposed for the first time, as an ‘anti-avoidance’ measure  CFC provisions to trigger if the following conditions are met:  There is a foreign company which is controlled directly or indirectly by an Indian resident  Such foreign company earns ‘passive income’Revised  Passive income is not distributed to the shareholders resulting in deferral of taxes  Accumulated passive income not distributed to the shareholders shall be deemed to have been distributed  Taxable in the hands of resident shareholders as dividend received from a foreign company
  • 11. CONTROLLED FINANCIALCORPORATION(Cont)  Term ‘control’ not defined - revised DTC expected to provide certain thresholds limit on ownership, nature of income and location of foreignInterpretation / issues company  No clarity as to how many layers could be taxed under the CFC regime  Whether the deemed taxation of dividend will be in the hands of the controlling shareholders or all the resident shareholders (including the minority)  CFC provisions may not apply in case a company is set-up in high tax jurisdiction
  • 12. TREATY VS DOMESTIC LAW
  • 13. TREATY VS DOMESTIC LAW  Provisions of the tax treaties or the DTC whichever is later in point of timeProposed shall prevail  Higher rate of taxation on royalty, fees for technical services and interest income etc, which are taxed in the source country at a concessional rate as per DTAAIssues  Uncertainty regarding cost of doing business in India will also affect foreign direct investment  Not possible to restore the preferential status of the DTAAs over domestic law by re-notification of all the existing DTAAs as they are bilateral agreements which cannot be re-notified unilaterally
  • 14. TREATY VS DOMESTIC LAW(Cont)  More beneficial provisions of the tax treaties or the DTC to apply, except where:Revised  the General Anti Avoidance Rule is invoked; or  the Controlled Foreign Corporation provision is invoked; or  branch profits tax is levied  Under DTC, every foreign company is liable to pay branch profits tax. TheInterpretation intent of not providing treaty benefits to companies paying branch profits tax is unclear
  • 15. TAXATION OF CAPITAL GAINS
  • 16. TAXATION OF CAPITAL GAINS  Distinction between long term and short term gains eliminated  Exemption for long term gains to be withdrawn; taxed at 30 percent (non-Proposed residents) and ordinary rates (residents)  STT proposed to be abolished; cost indexation for assets held for over one year  Base date for cost indexation shifted from April 1, 1981 to April 1, 2000  Considerable rise in the tax liability causing fluctuation in the capital market Tax at 30 percent for capital gains in the hands of non-residents is very highIssues  as they are currently being taxed at nil rate for equity shares, if held for more than one year
  • 17. TAXATION OF CAPITAL GAINS(Cont) • Capital gains to be treated as income from ‘ordinary sources’ for all taxpayers, including non-residents and taxed at applicable rates • Gains from transfer of listed equity shares / units held for more than one year • Deduction will be allowed at a specified percentage of the gains based on overall tax rates; no indexation benefit will be allowed • Similarly, capital losses will be scaled down by the specified percentageRevised • STT proposed to be calibrated based on revised taxation regime • Gains from transfer of other investment assets held for more than one year • Indexation benefit would be available with reference to base date of April 1, 2000 • Gains from transfer of assets held for less than one year • In respect of assets held for less than one year from the end of the financial year in which these were acquired, capital gains will be computed without the benefit of either a specified deduction or indexation
  • 18. TAXATION OF CAPITAL GAINS(Cont) • Imposition of tax on sale of listed securities vs Nil rate under the current regime – it may dampen the inflow of funds in the Indian capital marketInterpretation • Listed shares transferred on the floor of stock exchange and off the floor of stock exchange to be taxed in a similar manner – except that shares traded on stock exchange to bear additional tax in the form of STT • Benefit from long-term capital gains under section 54EC has not been provided; capital gains savings scheme also dispensed with
  • 19. TAXATION OF FIIs
  • 20. TAXATION OF FIIs  No special regime for FII taxationProposed  No guidance on income characterisation  Income of FIIs on purchase and sale of securities deemed to be capital gainsIssues  Income payable to FIIs will not be subject to withholding tax, therefore liable to advance tax in line with the current regime  Treaty exemption like capital gains exemption in Mauritius, may be hindered if GAAR is invoked; though invoking GAAR is highly litigativeRevised  No clarity on income from derivatives  Adverse implications for FIIs investing from treaty jurisdictions – ‘no PE no tax’ claim not available
  • 21. GENERAL ANTI AVOIDANCE RULES (GAAR)
  • 22. GENERAL ANTI AVOIDANCE RULES • GAAR introduced – powers to invoke vested with Commissioner • Applies to a tax avoidance transaction, if undertaken with the main purpose of obtaining a ‘tax benefit’ and the transaction: – is entered into or carried on in a manner not normally employed for bona fide businessProposed purposes; or – is not at arm’s length; or – abuses the provisions of the DTC; or – lacks commercial substance • Commissioner may disregard parties, reallocate/ re-characterize income or • disregard the arrangement or deny treaty benefits • Onus to prove that the transaction is bona fide shifted to the tax payer  Sweeping nature of GAAR; may be invoked by the CIT in a routine mannerIssues  Any arrangement to obtain a tax benefit may be considered as an impermissible avoidance arrangement  Suitable threshold limits for invoking GAAR should be considered
  • 23. GENERAL ANTI AVOIDANCE RULES(Cont)  Certain safeguards to be provided for successful implementation:Revised  CBDT to make rules for invoking GAAR;  A threshold limit (possibly a monetary limit) to be prescribed; and  Taxpayers allowed access to Dispute Resolution Panel, in cases where GAAR is invoked  Safeguards to provide some certainty on invocation of GAAR; however, it isInterpretation not clear whether GAAR would apply only prospectively or also to existing transactions  Efficacy of DRP yet to be tested
  • 24. SEZ – TAXATION OF EXISTING UNITS
  • 25. SEZ – TAXATION OF EXISTING UNITS • Shift from profit linked incentives to investment linked incentives • Tax holiday currently available to SEZ developers grandfathered underProposed DTC • No similar proposal for grandfathering tax holiday for SEZ units – Section 10AA of the Act Proposal to grandfather tax holiday for SEZ units for the unexpired periodRevised   No clarity as to transition date for grandfathering tax holiday – March 31, 2010 or March 31, 2011Interpretation  Uncertainty as to manner of computation of tax deduction for unexpired period for the SEZ units  Whether incentive available for SEZ units which have set-up the units in the SEZ but have not commenced operations till March 31, 2010 / March 31, 2011
  • 26. SEZ – TAXATION OF EXISTING UNITS(Cont)  Out of a total 578 formally approved SEZs, 353 are notified and only about 111 are operational, which themselves are not fully developed yet;Interpretation developers have already committed huge amounts towards land and are at various stages of development  Tax holiday for new units set up post commencement not provided - Are the developers still ready to commit huge amounts towards developing the zones with a risk of not finding any takers at the end
  • 27. INCOME FROM EMPLOYMENT
  • 28. INCOME FROM EMPLOYMENT • Amount received towards gratuity, commuted pension and voluntary retirement to be exempt only if the same is deposited in a Retirement Benefit Account (RBA) maintained with the permitted saving intermediaryProposed • Any withdrawals from RBA were to be subject to tax in the year of withdrawal • All perquisites, allowances except travel allowance were proposed to be taxable, leave encashment also taxable • Valuation of RFA for government employees at market value • The RBA scheme discarded Current regime to continue; receipts for voluntary retirement, gratuity, commuted pension, leave encashment continue to be exempt, subject to specified limitsRevised • Current valuation norms for perquisite in relation to medical facilities / reimbursements to be retained; exemption limits to be enhanced • Valuation of RFA on market values for government employees has been removed
  • 29. INCOME FROM EMPLOYMENT(Cont)Interpretation • Perquisites ruled to be notified • Exemptions in respect of HRA, LTC still not considered
  • 30. TAX TREATMENT OF SAVINGS
  • 31. TAX TREATMENT OF SAVINGS • EET scheme of taxation proposed for tax saving instrumentsProposed • Initial contribution deductible from income and accretions not taxable • Withdrawal from scheme taxable at any stage of withdrawal, taxable as ‘income from residuary sources • Most countries that follow the EET method of taxation of savings also have a social security system in place for all their citizens • In absence of a universal social security system, the proposed EET methodIssues of taxation of permitted savings would be harsh • Switching over to a complete EET system for all savings would entail administrative and technological challenges as a central authority is required to keep records and deduct taxes • Roll back to EEE scheme for specified Provident Funds, Superannuation Funds, Approved Pension Funds, Pure Life Insurance Products and AnnuityRevised Schemes • EEE status grandfathered for investments made before commencement of DTC in the instruments currently enjoying EEE status such as ULIPs, NSCs, FDs etc
  • 32. INCOME FROM EMPLOYMENT(Cont)Interpretation • Perquisites ruled to be notified • Exemptions in respect of HRA, LTC still not considered
  • 33. TAX TREATMENT OF SAVINGS
  • 34. TAX TREATMENT OF SAVINGS • EET scheme of taxation proposed for tax saving instrumentsProposed • Initial contribution deductible from income and accretions not taxable • Withdrawal from scheme taxable at any stage of withdrawal, taxable as ‘income from residuary sources • Most countries that follow the EET method of taxation of savings also have a social security system in place for all their citizens • In absence of a universal social security system, the proposed EET methodIssues of taxation of permitted savings would be harsh • Switching over to a complete EET system for all savings would entail administrative and technological challenges as a central authority is required to keep records and deduct taxes • Roll back to EEE scheme for specified Provident Funds, Superannuation Funds, Approved Pension Funds, Pure Life Insurance Products and AnnuityRevised Schemes • EEE status grandfathered for investments made before commencement of DTC in the instruments currently enjoying EEE status such as ULIPs, NSCs, FDs etc
  • 35. TAX TREATMENT OF SAVINGS(Cont)Interpretation • Definition of Pure Life Insurance Products has not been provided • No deduction for savings in instruments like NSC, post office saving account, term deposits, etc • No benefit for principal repayment on housing loans
  • 36. INCOME FROM THE HOUSE PROPERTY
  • 37. INCOME FROM THE HOUSE PROPERTY • Gross rental value of let out property to be computed at contracted rental value or presumptive rent, whichever is higherProposed • Presumptive rent to be calculated at 6 percent per annum on – the rateable value fixed by the local authority; or – on the cost of construction / acquisition of the property, if rateable value is not fixed • No deduction on interest payable on borrowed capital for construction / acquisition of a house property for self occupation • Inequitable – It discriminates against recent owners as construction cost is a function of inflationIssues • To incentivize investment in housing, the deduction for interest on borrowed capital should be retained for self occupied property • Gross rent proposed to be computed on the basis of amount of rent receivedRevised or receivable on contractual basis – Presumptive basis has been dropped • Individual or HUF will be eligible for deduction on account of interest on capital borrowed for construction / acquisition of a house property for self occupation, subject to a maximum of INR 150,000
  • 38. INCOME FROM THE HOUSE PROPERTY(Cont)Interpretation • Removal of presumptive basis of determining gross rent would benefit owners of properties which are not let out - under the Income-tax Act only one self occupied property is exempt, rest are treated as ‘deemed to be let out’
  • 39. TAXATION OF NON-PROFIT ORGANIZATIONS
  • 40. TAXATION OF NPOs • NPOs under the Income-tax Act, 1961 required to re-registerProposed • NPOs not permitted to accumulate and carry forward surplus • No provisions for exemption for public religious trusts and religious- cum-charitable trusts • Fresh registration – increase in the compliance cost for NPOs and also workload of the income-tax department • Where NPOs receive grants at the end of the financial year and are unable to spend due to reasons beyond their control - In the absence of any windowIssues for carry forward of surplus for use in the subsequent years, taxation of the surplus of income over expenditure will be harsh • Phrase ‘charitable purpose’ should be used instead of ‘permitted welfare activity’ in order to emphasize the charitable intent of the activities • Option to choose cash or mercantile system should be allowed
  • 41. TAXATION OF NPOs(Cont) • No need for existing NPOs to re-register – only required to submit information to facilitate administration under the new scheme • NPOs permitted to accumulate and carry forward up to 15 percent of their surplus or 10 percent of their gross receipts, whichever is higher, for use within 3 years from relevant financial year • To maintain continuity and minimise litigation, phrase ‘charitable purpose’ would be used instead of ‘permitted welfare activity’Revised • However, to the extent surplus is accumulated, donation to another NPO is not a permissible application • Surplus not applied and not eligible for carry forward to be subject to tax only beyond a basic exemption limit • Cash system of accounting retained, being simple to follow and easy to administer • Tax exemption and eligibility criteria for public religious trusts and religious-cum charitable trusts provided for’
  • 42. WEALTH TAX
  • 43. WEALTH TAX • Assets chargeable to wealth-tax shall mean all assets, including financialProposed assets and deemed assets, as reduced by exempted assets • Net wealth of an individual or HUF in excess of INR 50 crore shall be chargeable to wealth-tax at the rate of 0.25 per cent • Productive assets should be exempted from wealth tax as under the Wealth tax ActIssues • Threshold limit of INR 50 crore for levy of wealth tax is too high • Tax on financial assets will be harsh as they are currently exempt • Wealth Tax will be levied broadly on the same lines as the current regimeRevised • Threshold limit and rate of tax will be suitably calibrated in line with overall tax rates
  • 44. UNADDRESSED ISSUES
  • 45. UNADDRESSED ISSUES • No clarity on taxability of indirect transfer of capital assets • Business reorganisation: • Term business reorganization defined to mean the reorganization of two or more residents, Companies Act, 1956 and Companies Bill, 2009 permits merger of a foreign company with Indian company • Only transfer of investment assets in business reorganisation is exempt, no similar provision for business assetsIssues • Slump sale • Cost of acquisition of investment asset/ depreciable business asset based on the cost / WDV for the previous owner • No provisions for determining the cost of acquisition of non depreciable business assets in the hands of the successor • Absence of the provisions giving precedence to the terms of the Production Sharing Contract (PSC) – inter-play of the DTC with the PSC unclear
  • 46. ACT vs DTC vs RDTC
  • 47. ACT VS DTC VS RDTC Provisions Act DTC Revised DTC MAT levy on gross MAT levy on book Mat levy on book assets MAT profits Rate – 2 percent (0.25 profits Rate 19.93 percent Rate – to be decided percent for banks) EEE scheme toTaxation of continue for specified EEE scheme savings applicable EET scheme savings viz PPF, GPFinstruments EET to apply for other saving instruments Basic exemption limit to be prescribed in respect of income of Income of NPOs NPOs to be taxed at NPO exempt, subject to the 15 percent of total Public religious trusts NPOs specified threshold income on the basis of and religious-cum limit, and conditions for cash system of charitable utilization of funds accounting trusts eligible for exemption, subject to specified conditions
  • 48. ACT VS DTC VS RDTC(Cont) Provisions Act DTC Revised DTC Resident in India if the Resident in India if its Resident in India if the Foreign ‘control and ‘place of effective ‘whole of control and management’ of its management’ is in Company – management’ of its affairs is situated IndiaTax residency affairs is situated in ‘wholly or partly’ in ‘Place of effective India India management’ defined DTAA or DTC, which DTAA to prevail over In the case of a conflict is domestic law, if DTAA between the provisions beneficial will apply, DTAA provisions more of DTAA and DTC, the except in case of beneficial to the one later in time will GAAR / CFC / branch taxpayer prevail profit tax Income from Retirement benefits to Specified retirementEmployment – Retirement benefits be exempt only if benefits to continue to retirement exempt subject to deposited in RBA and be exempt benefits and specific monetary limits will be subject to tax on Scheme of setting up withdrawal RBA dispensed with perquisites
  • 49. ACT VS DTC VS RDTC(Cont)Provisions Act DTC Revised DTCCapital gains on LTCG and STCG – LTCG - taxable at the LTCG and STCG – taxable at applicabletransfer of other rate of 20 percent taxable at applicable rates for residents; forinvestment STCG – taxable at non-residents at 30 rates for residents andassets applicable rates non-residents percent Foreign companies controlled by Indian residents and earning passive income whichCFC No concept of CFC No concept of CFC is not distributed to be taxed in the hands of resident shareholders as dividends
  • 50. ABOUT US
  • 51. ABOUT US• Arkay & Arkay Chartered Accountants (Arkay & Arkay) is a premier full services firm, providing quality Tax, Assurance and Advisory services to stalwarts of the Indian Industry.• We at Arkay & Arkay, strive to help our clients and our people in attaining their goals and exceeding their potential. Our team is a mixture of youth and experience possessing the energy and enthusiasm of a start-up and the maturity that being in the business for over 30 years brings.• Arkay & Arkay are advisors in thick and thin, while we serve industry giants our Entrepreneur’s Cell ensures that help is available for the bright stars of the business world while they are still in the fledgling state.• Our Entrepreneur’s Cell provides help from the very inception of the business, assisting in fleshing out the business plans, providing guidance through the process of incorporation, aiding in securing the requisite capital while simultaneously assisting in business management through its growth.• Arkay & Arkay shall help the client navigate the troubled seas that the Indian legal and compliance system while ensuring that the client can stay focused on its business objective. We help you mind your own business.
  • 52. OUR TEAM
  • 53. OUR TEAM• Our team of Chartered accountants, Company Secretaries, MBA’s and Lawyers is determined to help you leverage your business to help it grow and to attain the lofty heights of success. We provide a suite of services in the realms of Taxation, Assurance and Advisory to manage, measure and improve your bottom-line, respectively
  • 54. OUR CLIENTS
  • 55. SOME OF THE INDUSTRIES SERVED * Individual client names have not been disclosed in compliance with ICAI guidelines 56
  • 56. www.arkayandarkay.com Pallav@arkayandarkay.comRknarang@arkayandarkay.com +91-9910124927 +91-9818014509 +91-11-27940068 +91-11-27947030 57