Volume 3, Issue 23


3rd Mar, 2011


Tax Alert
Budget Alert for Foreign Investors
The Budget presented this time contains very few amendments to the current Income Tax Act, 1961. This is primarily on account of the fact that the Government seems serious about replacing the existing Income-tax Act, 1961 with the Direct Tax Code (DTC), which is proposed to be made effective from 1st April 2012.
     

The Indian Union Budget 2011 was presented in the Parliament by the Finance Minister Mr. Pranab Mukherjee on 28th February 2011.

The Budget presented this time contains very few amendments to the current Income Tax Act, 1961. This is primarily on account of the fact that the Government seems serious about replacing the existing Income-tax Act, 1961 with the Direct Tax Code (DTC), which is proposed to be made effective from 1st April 2012.

The significant proposals on direct taxes having an impact on the regulations and the taxation of Foreign Institutional Investors (FII) in India are highlighted as under:

Key announcements/changes:

Tax Reforms

The current Income Tax Act has been in force since 1961 - for a period of more than 50 years. The proposed DTC would mark the beginning of a new era in the regime of Indian tax law and is regarded as the most eagerly awaited change in the Indian tax system. The DTC was first unveiled in August 2009 and is presently referred to the Standing Committee of the Parliament for a detailed examination. The DTC is expected to simplify the law and make it easier to comprehend for the common man. It is also likely to bring about substantial changes that would have an impact on the taxation of cross border transactions in India.

Investment related changes

  1. Investment in SEBI Registered Mutual Funds
    Prior to the budget only FIIs, sub-accounts registered with SEBI and NRIs were allowed to invest in mutual fund schemes. In order to liberalize the portfolio investment route, the Government has decided to permit SEBI registered mutual funds to accept subscriptions from foreign investors provided they meet the KYC requirements for equity schemes. The objective of this proposal is to enable the Indian Mutual Funds to have direct access to foreign investors and widen the class of foreign investors in Indian equity market.

  2. Increase in FII limit for investment in corporate bonds issued by infra-structure companies :
    In order to boost further foreign investment in the infrastructure sector, the existing FII limit of USD 5 billion for investment in infrastructure corporate bonds is proposed to be raised by an additional amount of USD 20 billion taking the limit to USD 25 billion. This will raise the total limit available to the FIIs for investment in corporate bonds to USD 40 billion.
  1. FIIs allowed to invest in bonds of unlisted infrastructure SPVs :
    Most of the infrastructure companies are structured as SPVs. Therefore, FIIs would also be permitted to invest in unlisted bonds but with a minimum lock in period of three years. At the same time, the FIIs will be allowed to trade amongst themselves during the lock in period.
The Income-tax department has also set up a presence in a few countries like Mauritius and a representative of the department is now located in these countries. This is a significant development which will enable the Indian Tax Authorities to gather information on cross-border transactions in a speedy and efficient manner.

Tax Information Exchange Agreements/DTAAs

During the year, Foreign Tax division of the Central Board of Direct Taxes has been strengthened to effectively handle the increase in tax information and transfer pricing issues. A dedicated Cell for exchange of information is also being set up. During the past year, India has finalised discussions for 11 TIEAs and 13 new DTAAs along with revision of provisions of 10 existing DTAAs. Further, the Income-tax department has also set up a presence in a few countries like Mauritius and a representative of the department is now located in these countries. This is a significant development which will enable the Indian Tax Authorities to gather information on cross-border transactions in a speedy and efficient manner.

Tool box to discourage transactions with non-cooperative nations /Jurisdictions

A new tool box is sought to be given to the tax authorities to deal with transactions with entities located in non-cooperative countries/jurisdiction. Section 94A is proposed to be inserted in the Act as an anti avoidance measure to discourage transactions by resident taxpayers with persons located in a country which does not exchange information with India and the Government can notify such country or territory as a “Notified Jurisdictional Area”.

The proposal provides for following consequences in case a tax payer enters into transaction with a person located in that notified jurisdiction area.

  1. The parties entering into such a transaction shall be regarded as “associated enterprises” and the transaction shall be deemed to be an “international transaction” and accordingly, the transfer pricing provisions shall apply to such a transaction.
  2. Deduction in respect of a payment made to any financial institution located in a notified jurisdictional area will not be allowed to the payer unless the tax payer furnishes an authorisation, in the prescribed form, authorising CBDT or any income tax authority acting on its behalf to seek relevant information from the said financial institution.
  3. Deduction in respect of any other expenditure (including depreciation) arising from the transaction with a person located in a notified jurisdictional area shall not be allowed unless the tax payer maintains such other documents and furnishes the information as may be prescribed.
  4. If any sum is received from a person located in the notified jurisdictional area then the onus is on the tax payer to satisfactorily explain the source of such money and in case of his failure to do so the amount shall be deemed to be the income of the tax payer. This provision is similar to an existing provision which empowers the tax authorities to treat unexplained credits as the recipient’s income.
  5. Any payment made to a person located in the notified jurisdiction shall be subject to deduction of tax at the higher of the rates specified in the relevant provision of the Act or rate or rates in force or a rate of 30%.

Although it is too early to comment, it is possible that the above provisions could have implications for the local custodians, brokers, depositories, FIIs, etc. who are in receipt of any sum from a person from such a notified jurisdictional area unless they can satisfactorily explain the source of such funds.

The above provisions would be applicable from 1st June 2011.

Infrastructure debt fund is proposed to be set up to bring in low cost long term funds from foreign countries to India. Income of such infrastructure debt fund would be exempt from tax.

Setting up of Infrastructure Debt Fund and tax treatment of Income of such fund and interest earned by investors from the fund

A dedicated Infrastructure debt fund is proposed to be set up to bring in low cost long term funds from foreign countries to India. Income of such infrastructure debt fund would be exempt from tax. Similarly, interest received by a Non resident from such notified infrastructure debt fund would be taxable at the concessional rate of 5% plus surcharge and cess on the gross amount of income. The said interest would be subject to withholding tax at the same rate i.e. 5% plus applicable surcharge and cess.

The above provisions would be applicable from 1st June 2011.

Reporting requirement for Liaison offices (LO) in India

At present, LOs generally do not file a tax return in India. Going forward, every non-resident having an LO in India is required to report the activities of such LO conducted or performed in India to the Income Tax Authorities within 60 days from the end of the financial year in a specified form. It may be noted that this provision is similar to the existing RBI regulation which requires LOs to file a report with RBI after the end of every year.

The above provisions would be applicable from 1st June 2011 and will be applicable from FY 2011-12 onwards.

Where information is required to be obtained from the tax authorities outside India, the period from the date of making reference to the foreign tax authorities to the date on which the information is received in India is proposed to be excluded from the statutory time limit available for completion of assessment or reassessment.

Certain other Tax proposals relating to collection of information

  1. It is proposed to confer powers on certain levels of tax officers to make an enquiry or investigation in pursuance of a request received from a tax authority outside India.
  2. Similarly, it is proposed to empower the tax authorities to impound and retain any books of account and other documents produced before the said Income Tax authority in any proceeding under the Act referred to above.
    Where information is required to be obtained from the tax authorities outside India, the period from the date of making reference to the foreign tax authorities to the date on which the information is received in India is proposed to be excluded from the statutory time limit available for completion of assessment or reassessment. However the time so excluded cannot exceed six months. This in effect provides additional time to the Indian Tax Authorities to gather information from Foreign Tax Authorities for the purpose of assessments or reassessments.
    The above provisions would be applicable from 1st June 2011

Certain other Tax proposals

  1. The surcharge payable by corporate tax payers is proposed to be reduced from 7.5% of the tax payable to 5% for domestic companies and from 2.5% of the tax payable to 2% for foreign companies
  2. The rate at which Minimum Alternate Tax (MAT) is payable by companies is proposed to be increased from 18% to 18.5%. The effective rate of MAT for foreign companies has now increased from 19.0035% to 19.4361%
  3. Limited Liability Partnerships (LLPs) are now proposed to be subjected to Alternate Minimum Tax @ 18.5% of the adjusted total income on similar lines of MAT for companies. The adjusted total income is the Gross Total Income of the LLP increased by deductions under Chapter VI-A and section 10AA. The AMT paid will be allowed as a credit in the next 10 years, identical to the provisions of MAT credit for companies.
  4. Special Economic Zone (SEZ) developers are now proposed to be brought under the MAT regime and also, the dividend declared by such companies would be subject to Dividend Distribution Tax. Hitherto, such companies enjoyed exemption from both these provisions.

Based on the proposed changes, the tax rates applicable to FIIs would be as mentioned in the adjoining Tax Rate Chart for FIIs for F.Y. 2011-12.

Tax Rate Chart for FIIs for F.Y. 2011-12

Sr. No. Nature of Income     Non Corporate Assessee
1   Total Income up to INR. 10 Million Total Income exceeding INR 10 Million  
2 Business Income 41.20% 42.024% 30.90%
3 Interest from and in respect of securities 20.60% 21.012% 20.60%
  Capital Gain 15.45% 15.759% 15.45%
  STCG (STT paid) 30.90% 31.518% 30.90%
  STCG (without STT) Exempt Exempt Exempt
  LTCG (without STT) 10.30% 10.30% 10.30%
4 Dividend/Income from Units Exempt Exempt Exempt
5 Interest received from infrastructure debt fund 5.15% 5.253% 5.15%
 
Notes:
1. Tax rates for corporate assessees having income exceeding INR 10 million are inclusive of surcharge @ 2.0% of the tax and education cess @ 3.0% of the tax and surcharge.
2. Tax rates for Non corporate assessees are inclusive of education cess @ 3.0% of the tax. No surcharge is levied for non-corporate assessees.
3. The interest received from infrastructure debt fund will be taxable at the above mentioned rates from 1st June 2011.
4. Dividends/Income from shares/units will be exempt provided the Indian Company/Mutual Fund declaring the dividend/income pays Dividend/Income Distribution Tax on the dividend/income declared.