Volume 5, Issue 33

14th March, 2013

Tax Alert
Indian Budget & its impact for foreign investors

Introduction and Background:

The Finance Bill, 2013 (the Bill) was presented by the Finance Minister (FM) Mr. P. Chidambaram on 28th February 2013. This year’s budget was keenly awaited by the entire business community and the investor fraternity since there were expectations that the FM would provide clarifications on retrospective amendments and indirect transfers which have been subject matter of intense and heated discussion for more than a year. However, this year’s budget was pragmatic but not rich in ambitious reforms to spur growth.

This tax alert summarises the key proposals with respect to the international tax regime and our analysis regarding their impact.

  1. General Anti Avoidance Rules (GAAR)

Some of the key recommendations of the Shome Committee (the committee) have been accepted by the Government and accordingly changes have been proposed in the GAAR provisions under ITA.

The most notable proposal is to defer the implementation of GAAR by two years and now it is proposed to be introduced from FY 2015-16. The other key amendment is that GAAR provisions should apply to any impermissible avoidance arrangement (‘IAA’) only where the main purpose is to obtain tax benefit (as against the erstwhile condition of requiring it to be main purpose or one of the main purposes). However, the recent amendment proposes that onus of proving that an arrangement is not an IAA is on the taxpayer.

The constitution of the Approving Panel for determining the applicability of GAAR, as introduced by Finance Act 2012 comprised of not less than three members being:

  • Income tax authorities not below the rank of Commissioner; and
  • An officer of the Indian Legal Service not below the rank of Joint Secretary to the Government of India;

The Bill proposes to amend the constitution of the Approving Panel to lend more credibility to the panel, which is now as follows:

  • a present or retired judge of a High Court as the Chairman; and
  • one member from the Indian Revenue services not below the rank of Chief Commissioner of Income tax; and
  • one member shall be academic or scholar having special knowledge of direct taxes, business accounts and international trade practices.

SKP’s Comments:

It would be pertinent to note that the FM had issued a press release in January 2013 wherein he had considered various recommendations made by the committee on GAAR and accepted some of the key recommendations. However, it was surprising that the following key recommendations which were accepted in the press release did not find place in the Bill:

  • Grandfathering of existing investments: The committee had recommended that investments (albeit not arrangements) existing as on the date of commencement of GAAR should be grandfathered so that on exit on or after the said date, GAAR provisions are not invoked for examination or denial of tax benefit. The Government partially accepted the above proposal ie grandfathering to be provided for investments existing on or before 30th August 2010 (ie the date on which the Direct Tax Code bill was first introduced).
  • Monetary Threshold: The committee had recommended a monetary threshold of INR 3 Crore of tax benefit in the arrangement to invoke GAAR.
  • GAAR provisions should not apply to FIIs/investors in FII who choose not to obtain any benefit under tax treaty and apply the provisions of the ITA.
  • GAAR should not be invoked where SAAR is applicable. The Government had stated that in cases where both the aforesaid provisions could be applicable, only one of them shall prevail.
  • The tax consequences of IAA should be such that a corresponding adjustment is allowed in the case of the same assessee in the same year and different years.
  1. Tax Residency Certificate (‘TRC’)

One of the most contentious amendments proposed in the Bill was in the context of TRC. It is proposed that a non-resident would be required to obtain a TRC from its home country in a specified format and the same would be a necessary condition but not sufficient for claiming tax benefits under a tax treaty. To make things worse, this amendment is proposed to be applied retrospectively from FY 2012-2013.

SKP’s Comments:

This amendment has challenged the validity of the Circular No. 789 dated 13 April 2000 issued by the Central Board of Direct Taxes and also the ruling of Supreme Court Ruling in the case of Azadi Bachao Andolan which stated the TRC shall be sufficient evidence of residential status and beneficial ownership in the context of Mauritius based entities.

Serious concerns were expressed by foreign investors regarding this clause in the Bill since language of the proposed amendment would mean that TRC issued by tax authorities of foreign country could be questioned by the income tax authorities in India.

In order to soothe the frayed nerves of the foreign investors, the FM has issued a press release on 1st March 2013 wherein he clarified that TRC will be accepted as evidence of residency and the Income Tax authorities in India will not challenge the TRC. The FM also acknowledged that the amendment proposed in the Bill in respect of TRC is clumsily worded and the same would be changed while the Bill is presented for discussion.

  1. Taxation of Income by way of Royalty/Fees for Technical Services (‘FTS’)

The Bill has proposed a steep increase in the tax rate from 10% to 25% in respect of royalty and FTS income earned by non-resident tax payers.

SKP’s Comments:

The FM, in his budget speech had mentioned that tax rates for royalties and FTS provided under some of the tax treaties are higher than the rates provided under the ITA. In view of the same, he has proposed to increase the tax rates to 25%. However, it would be pertinent to note that most of the tax treaties have a tax rate in the range of 10% to 15% only. Further, the proposed amendment would also cause severe hardship to non-resident tax payers located in jurisdictions with whom India does not have a tax treaty.

  1. Additional income tax on Buy-Back of Shares by Unlisted Companies

It is proposed that on buy-back of shares by unlisted companies, the companies would be liable to pay an additional income tax at the rate of 20% on the consideration paid to the shareholder (i.e. distributed income). The distributed income will be the difference between the amount paid to the shareholder on buy-back of shares and the amount that was received by the company while issuing those shares.

The consideration received on buy-back of shares of unlisted domestic companies will be exempt in the hands of the shareholder.

SKP’s Comments:

  • This amendment may trigger challenges for shareholders to claim foreign tax credit in home country on such capital gains.
  • This provision would be most unfair in cases where a shareholder has acquired the shares from the original shareholder at a price higher than the price at which the company had originally issued the shares. In such cases, even though the shareholder (who offers his shares for buy back) may have paid a much higher price, the amount that will be taken into consideration by the company while computing the tax payable will be the amount that it received from the original shareholder at the time of issue of the shares. This may lead to taxing the same income twice. We have provided below an example for better understanding:

Mr. A is allotted shares of ABC Ltd at the time of incorporation of the company at an issue price of INR 10. He sells these shares to Mr. B at a value of INR 30. At a later date, ABC announces buyback of shares at INR 100. The tax implications in the hands of each stake holder pre and post the proposed Bill would be as under:

Taxability – Prior to the proposed amendment Taxability – Post the proposed amendment
Taxability in the hands of Mr. A
Sale price 30 Sale price 30
Less: Cost of acquisition (10) Less: Cost of acquisition (10)
Capital gains (A) 20 Capital gains (A) 20
Taxability in the hands of Mr. B
  INR Not Taxable NIL
Buy-back price 100
Less: Cost of acquisition (30)
Capital gains (B) 70 Capital gains (B) NIL
Taxability in the hands of ABC Ltd.
Not Taxable NIL   INR
Buy-back price 100
Less: Issue price of shares (10)
Capital gains (C) NIL Income on which tax is payable (C) 90
Total Capital gains (A+B+C) 90 Total taxable income (A+B+C) 110

It is evident from the above illustration, that the income of INR 20 [ie INR 30 (being the cost of acquisition in the hands of Mr B) - INR 10 (being the original issue price of shares)] is taxed twice, though in the hands of different tax payers.

  1. Other key proposals

    1. Removing Cascading Effect of Dividend Distribution Tax (DDT

    As per the present provisions, when a domestic holding company receives dividend from its domestic subsidiary, the said dividend income is not liable to DDT when the Indian holding company declares dividend. This benefit is proposed to be extended to dividends received from the foreign subsidiary company also, since the domestic holding company shall pay tax at 15% on such dividend. This provision is proposed to be inserted from 1st June 2013.

    SKP’s Comments

    Prior to this amendment, the domestic companies receiving foreign dividend were liable to pay tax on the dividend income received and also DDT on onward distribution of such dividend. However, a specific exemption from DDT was given in respect of dividends received from domestic subsidiaries since they were paying DDT on dividend distributed. This amendment seeks to eliminate the disparity and hence it’s a welcome move which would further encourage foreign inflows.

    1. Dividends Received from Foreign Companies

    In order to encourage repatriation of income earned outside India, the Finance Act 2012 provided for a concessional rate of tax of 15% on gross basis on dividends received from a foreign company up to 31st March 2013. It is now proposed to extend the benefit of the concessional rate of tax of up to 31 March 2014.

    SKP’s Comments

    In addition to this amendment, the FM in his speech has laid emphasis on encouraging inflow of foreign funds in India. Accordingly, the extension by one more year in respect of the concessional rate of tax for foreign dividends is a move in line with the stated intent of the Government.

    1. Safe Harbour Rules

    The Safe Harbour Rules are expected shortly.  

    SKP’s Comments

    The much awaited Safe Harbour Rules shall provide certainty of tax outflows and avoid litigation costs and efforts. Further, a safe harbour mechanism would provide a measure of predictability as well as continuity for all participating organisations. However, implementation of the same at earliest would bring some cheer to the foreign investors.


The amendments brought about by the FM have left the foreign investors high and dry. The ambiguity around TRC, the effect of last year’s retrospective amendments on indirect transfers being untouched, non acceptance of some of the key proposals of the committee on GAAR have created an apprehension in the minds of foreign investors. In order to win the confidence of the foreign investors, we hope that the FM shall at least consider the recommendations of the committee already accepted by him but not included in the Bill, at the time GAAR is actually implemented. However, for now, it’s “wait and watch” for the foreign investors.