Indian Finance Minister, Nirmala Sitharaman, has released the country’s latest Budget proposing a slew of tax measures.
First, the Budget – presented to Parliament on February 1 – proposes to tax distributed income by Real Estate Investment Trust (REIT) and Infrastructure Investment Trust (InVIT) – commonly referred to as business trusts – in the hands of a unit holder (other than dividend, interest or rent which is already taxable) on which tax is currently avoided both in the hands of unit holder as well as in the hands of business trust.
Finance Act 2014 introduced a special taxation regime for business trusts. The special regime was introduced in order to address the challenges of financing and investment in infrastructure. The business trusts invest in special purpose vehicles (SPV) through equity or debt instruments.
An Explanatory Memorandum published alongside the Budget states that “dual non-taxation of any distribution made by the business trust, that is, which is exempt in the hands of the business trust as well as the unit holder, is not the intent of the special taxation regime applicable to business trusts.”
Commenting on the proposal, Vinita Krishnan, tax partner at Khaitan & Co, said: “While the Government’s objective behind proposing this amendment is to ensure that any income received by the REIT/InvIT on repayment of debt (and which is distributed to investors) does not escape tax in the hands of both the REIT/InvIT and the unitholders; the proposed language is widely worded and, hence, the scope of this provision needs to be carefully examined to identify any other income streams which could fall within its purview.”
“Further, as per this proposal, income arising to the unitholder on redemption of its units would be taxable as ordinary income (at a higher base tax rate ranging from 30 percent to 40 percent), as compared to capital gains (base rate ranging from 10-20 percent, if long-term capital gains),” Krishnan added.
“Notably, gains on secondary exits continue to be taxed as capital gains. In case of non-residents, while several tax treaties provide an exemption for capital gains from sale of units, an exemption for ‘other income’ is limited to very few treaties. Cleary, unitholders need to plan their return/exit from REIT/InvIT carefully given the differential tax treatment in case of redemption vs secondary exit,” Krishnan said.
Next, the Budget proposes to extend taxability of the consideration (share application money/share premium) for shares exceeding the face value of such shares to all investors including non-residents.
Meyyappan Nagappan, tax partner at Trilegal, said that “the move to impose taxes on the Indian company when it issues shares to non-residents at a premium (or above the fair market value calculated through prescribed methods) was a surprise and could impact prior investments by offshore investors into convertible instruments issued by an Indian company, where the price of conversion is less than the prescribed fair market value.”
“In such a case, there could be a tax outflow, which is not beneficial to the investor or the company and this could impact both current and future investments by non-residents into Indian companies,” Nagappan added.
Krishnan cautioned that share issuance transactions involving equity/convertible instruments be carefully structured from a valuation perspective, ensuring compliance with requirements under company law, tax, and exchange control regulations.
“Per the current Indian tax laws, any excess premium received by a closely held Indian company upon allotment of shares to resident shareholder is taxed as its ordinary income (referred as ‘angel tax provisions’). Initially intended to curb money laundering, the angel tax provisions have been extended to non-residents as well. Interestingly, the Indian company law and exchange control also prescribe certain valuation norms in case of share issuances,” she clarified.
Shilpa Goel, Income Tax Department’s Standing Counsel in the Bombay High Court, said that the Finance Minister’s Amrit Kaal Budget envisions technology-driven and knowledge-based economy with strong public finances, and a robust financial sector.
“The Budget proposals aim to maintain continuity and stability of taxation, further simplify and rationalize various provisions to reduce the compliance burden, promote the entrepreneurial spirit, and provide tax relief to citizens,” Goel added.
Goel said that 100 Joint Commissioners would be deployed to reduce the pendency of appeals at Commissioner level, and the Department would be more selective in taking up cases for scrutiny of returns received this year.
“There are several other changes aimed at rationalization. Take for example, the exclusion of non-banking financial companies (NBFCs) from restrictions on interest deductibility,” Goel said.
Goel explained: “Currently, the restriction on interest deductibility on interest payment to overseas associated enterprise does not apply to those in the business of banking and insurance. Representations were received stating that certain NBFCs engaged in the business of financing should also be excluded as they are undertaking the similar functions. The Budget extends this benefit to NBFCs.”