– Pooja Balan

The Union Budget was presented by Finance Minister Mr Arun Jaitley in the Parliament on 1 February 2018. Each year the Budget presentation is one of the most-awaited events for businesses, individuals and professionals. The Budget presentation includes the sources of revenue for the Government (taxation) and Government’s spending plans by sector and program. Budget 2018 relates to the financial year 2018-19 and future years, i.e. most provisions are effective from 1 April 2018.

In his opening remarks for Budget 2018, Mr Jaitley said “The journey of economic reforms during the past few years has been challenging but rewarding. As a result of the reforms undertaken by the Government, foreign direct investment has gone up. Measures taken by the Government have made it much easier to do business in India.”  In this post we summarise the changes from Budget 2018 that will impact businesses in India, especially those with overseas shareholders.

1. Change in corporate tax rate for SMEs

The income tax rate for SME companies (having turnover/gross receipts up to INR 2500 million or ~USD 39 million in the year 2016-17) is reduced to 25%. This widens the scope of “SME” which previously only included companies with revenue of INR 500 million. A much larger number of companies will now receive the benefit of a lower tax rate. This will be especially helpful in the growth phase of a business.

2. Transfer pricing issues: Definition of “business connection”

As per India’s Double Taxation Avoidance Agreement (DTAA), an enterprise is deemed to have an agency permanent establishment (PE) only if a person acting in its behalf exercises authority to conclude contracts in name of enterprise. It is clear that to constitute an agency PE, a contract must be concluded in the name of the enterprise.

To take benefit of this loophole, enterprises enter into arrangements with intermediaries who sell products in their own name instead of its actual owner (i.e. the foreign enterprise). The intermediary is only taxed on his commission and the foreign enterprise cannot be taxed at all, since it has no PE in India.

Budget 2018’s modifications provide that an agent will include not only a person who concludes contracts on behalf of the non-resident, but also a person who plays a principal role leading to the conclusion of contracts (i.e. an intermediary). This will bring more foreign enterprises and their agents/intermediaries into the tax net.

3. Transfer pricing issues: Definition of “significant economic presence”

DTAAs state that business profit of an enterprise is taxable in the country in which the taxpayer is a resident. If an enterprise carries on its business in another country through a Permanent establishment (PE) situated therein, such other country may also tax the business profits attributable to the PE.

A PE is defined as a fixed place of business through which the business of an enterprise is wholly or partly carried out. With global digitalisation and e-commerce, new business models operating remotely through the internet have emerged. Non-resident enterprises now interact with customers in another country without a physical presence in that country.

Budget 2018 therefore proposes to define “significant economic presence” as any transactions or activities (above a prescribed limit) and/or systematic and continuous soliciting or interaction with potential customers in India digitally. These are irrespective of the location of the provider.

This rule will apply to several digital service and e-commerce providers that are based outside India but cater to users in India. Budget 2018 proposes to ascertain the share of revenue of a multinational earns from India (with or without a PE) and bring it within the tax ambit.

4. Implementation of Long Term Capital Gains (LTCG) tax on listed shares

Earlier, long term capital gains on listed shares were exempted from tax. (LTCG on listed shares or mutual funds is a gain on selling shares after holding them for at least a year.) This benefit is now applicable only until sale of shares before 31 March 2018. After this, investors will pay 10% tax on profit exceeding INR 100,000 from the sale of listed shares or equity mutual fund schemes. The cost base for calculation of tax, however, will be the market value as at 31 January 2018 or actual cost, whichever is higher.

The LTCG provisions on unlisted shares remain unchanged. These provide for 20% tax on capital gain on sale of shares in a private company.

5. Loans to shareholders could be subject to Dividend Distribution Tax

Section 2(22)(e) defines dividend to include any payment by way of loans/advances made by a private company (with accumulated profits) to any shareholder who holds >10% voting power.

Indian companies pay dividend distribution tax (typically c.20%) on distributions instead of the recipient paying tax. To avoid payment of tax, some companies pay dividends to shareholders in the form of “loans and advances”. Budget 2018 therefore proposes a tax of 30% (without grossing up) on loans to directors or their entities.

6. Longer lock-in period for investment in tax-saving bonds

Section 54EC provides an exemption from tax on capital gain arising on transfer of any long term capital asset, if the proceeds are invested in bonds issued by National Highway Authority of India and Rural Electrical Corporation Limited. This is typically used to cover assets such as land, building/property, machinery, etc.

Earlier, capital gain exemption could be availed only if the bonds are not redeemed  within 3 years of their acquisition. This holding period has been extended to 5 years as per Budget 2018.

7. New Section 43AA 

   The existing Section 43A of the Act provides that if there is a change in the cost of an asset due to change in foreign exchange rates, the cost of the asset include the additional forex cost. Budget 2018 now proposes a new section (43AA) which, subject to 43A, provides that foreign exchange conversions are to be brought in line with the ICDS disclosures. These disclosures deal with foreign exchange gain/loss and translation gain/loss, among others. Further clarifications are awaited but it is likely that year-end forex translation gains/losses may be considered as business gains/losses based on this.

8. Non applicability of MAT in case Foreign Companies opt for presumptive taxation

Section 115JB deals with Minimum Alternate Tax (MAT). According to this section, every company must pay MAT if its regular income tax (payable on the tax profit) is <18.5% of its book profit. This is a mechanism to ensure a certain minimum taxability for companies with large tax exemptions or benefits.

Budget 2018 proposes an amendment to the MAT provisions for foreign companies if they are engaged in certain businesses. These businesses are: shipping, oil & gas exploration, aircraft operations, civil construction for certain turnkey power projects. These were previously taxed at rates between 5% and 10% (plus surcharge and cess). 

9. Change in Basic Customs Duty

Budget 2018 makes the following changes in the rate of Basic customs duty. As such, if a business imports these products, it can expect them to get more expensive. (This is an abbreviated list)

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Reactions to Budget 2018 have been varied, with some labeling it socialistic and others praising the pro-business changes. However as India moves towards a more transparent and simplified tax system that also aligns with global systems, the changes will only benefit business owners. It is important to see changes from a long-term view for businesses rather than how they will impact the next one year.

For more details on our transfer pricing services, direct tax services and services for companies entering India, please see: Transfer pricing Direct Tax India Strategy