BDO Corporate Tax News

India’s Union Budget 2024-25 was presented by the Finance Minister at a time when the global economy has struggled to maintain a steady growth rate due to war, supply chain disruptions and worldwide inflation. With the aim of India becoming a developed nation, the budget—announced on 23 July 2024—envisages sustained efforts on productivity and resilience in agriculture, employment and skilling, inclusive human resource development and social justice, manufacturing and services, urban development, energy security, infrastructure, innovation, R&D and next generation reforms. From a tax perspective, the budget makes an earnest attempt to simplify taxation, improve taxpayer services and reduce litigation and includes amendments that would affect international investors, as described below.

Reduction in the tax rate of foreign companies

Foreign companies have been taxed at a rate of 40% (excluding the applicable surcharge and cess) on income other than specific income (royalties, fees for technical services, etc.). As per the budget, the tax rate drops to 35% (excluding the applicable surcharge and cess) with effect from FY 2024-25.

Abolition of Equalisation Levy 2.0 (EL 2.0)

EL 2.0—introduced in 2020—is a 2% levy on revenue generated by nonresident e-commerce operators from the supply of goods or services in India that exceed INR 20 million during the financial year (FY) (for prior coverage, see the article in the June 2020 issue of Corporate Tax News). The EL targets online businesses that have a significant electronic presence in India but not a physical presence. Covered nonresident e-commerce operators are required to collect the EL and pay it over to the Indian government, thus creating an additional compliance burden.

Among the issues that have plagued EL 2.0 is the absence of definitions of certain key terms, resulting in the levy being applied beyond typical digital business models, with the services categorised as royalties/fees for technical services as per the Income-tax Act, 1961 and taxed at a higher rate. Additionally, the fact that the EL is a unilateral measure not classified as a tax has led to juridical double taxation, exacerbated by the broad scope of the EL.

Further, in 2021, the U.S. Trade Representative released a report concluding that the EL 2.0 is discriminatory, unreasonable and burdens or restricts U.S. commerce. It was proposed to impose 25% additional tariffs on certain Indian products, but the tariffs were not introduced because the U.S. and India agreed on a transitional approach to the EL during the interim period (which ended on 30 June 2024) until Pillar One rules on nexus and profit allocation came into effect.

To demonstrate its commitment to the Pillar One solution, the budget has abolished the EL 2.0, with the effect that consideration received or receivable for any e-commerce supplies of goods or services on or after 1 August 2024 will not be subject to the levy. It is unclear whether the INR 20 million turnover requirement would continue to apply proportionately until 1 August 2024 or whether the EL 2.0 would apply only if the full turnover threshold was reached. Consequently, the budget also exempts the income of e-commerce operators from supplies/services provided after 1 April 2020 but before 1 August 2024. 

Importantly, with the abolition of EL 2.0, taxpayers that previously were subject to the levy may need to evaluate the applicability of the “significant economic presence” provisions introduced via the Finance Act 2018 for jurisdictions that do not have a tax treaty with India. Under these rules, income derived by nonresidents that are considered to have a significant economic presence in India are deemed to have a “business connection” with India and are subject to income tax unless benefits are available under an applicable tax treaty.

Change in the tax treatment of share buybacks       

Previously, a 20% tax (excluding the surcharge and cess) was levied on an Indian company that repurchases its shares. The amount received under a buyback was exempt for the shareholder.

The budget includes the following measures that revise the tax treatment of proceeds from the buyback of shares with effect from 1 October 2024:

• The 20% buyback tax on companies and the shareholder exemption will be abolished. Tax liability will be shifted from the company to the shareholder so that the proceeds from a share buyback will be taxed in the hands of the shareholder as dividend income.

• A 10% withholding tax will be levied on the consideration paid by an Indian company.

• A shareholder will be able to claim the original cost of acquisition as a capital loss in respect of shares repurchased by the company. For this purpose, the consideration of shares repurchased will be deemed to be nil for purposes of computing such a capital loss. The resultant capital loss will be classified as long or short-term depending on how long the shares were held, and the setoff and carry forward provisions will apply. It is pertinent to note that the capital loss may lapse in the absence of any future capital gains.

• Taxpayers will be required to analyse the applicability of a relevant tax treaty to determine whether proceeds from a buyback of shares could be considered dividends or capital gains.

Rationalisation of the capital gains tax regime

The capital gains tax regime is overhauled to simplify the rules as from 23 July 2024. The previous regime was complicated with multiple holding periods and rates. For example, the Income Tax Act, 1961 had set out three holding periods for capital assets to determine whether the gain is short- or long-term: 12 months, 24 months and 36 months. The budget eliminates the 36-month holding period so that there are only two holding periods of 12 and 24 months to classify gains from the disposal of capital assets as short- or long-term gains.

A uniform tax rate of 12.5% is applicable to long-term capital gains (LTCG), regardless of whether the asset is listed or unlisted, whether Securities Transaction Tax is paid or not and whether the asset is held by a resident or nonresident, except for certain assets. It is further proposed to remove the benefit of indexation available for calculation of LTCG wherever hitherto available.

The tax rate on short-term capital gains (STCG) arising from the transfer of eligible listed securities is increased from 15% to 20%.

The above amendments can be summarised as follows:

(*Rates to be increased by the applicable surcharge and a 4% cess)

Other proposed amendments

The budget contains several other amendments that affect foreign investors:

• The interest deduction limitation rules (i.e., 30% of EBITDA) do not apply to financial companies operating in the International Financial Services Centre (IFSC), with effect from 1 April 2024.

• The government intends to reduce litigation and provide certainty in international taxation by expanding coverage of safe harbour rules and streamlining the transfer pricing assessment procedures.

• Penalties are being introduced for failure to file certain financial information by liaison/representative offices set up by nonresidents in India.

• The tax amnesty scheme is announced for tax disputes pending as of 22 July 2024, with any interest, penalties and prosecution waived for taxpayers participating in the in the initiative (no effective date has yet been provided). 

BDO comments

The budget amendments are focused on reducing ambiguities and minimizing the compliance burden for nonresident taxpayers. Therefore, it is expected to have a positive impact leading to increased participation of nonresident taxpayers in the Indian eco-system. Nevertheless, considering the changes, nonresident taxpayers already in India, as well as those looking to establish themselves in India, should become familiar with the amendments and evaluate their impact.

While the reduction of the nonresident corporate tax rate from 40% to 35%, abolition of EL 2.0 and simplification of the capital gains tax provisions are welcome from a foreign investors’ perspectives, such investors may now have to evaluate the applicable tax on their unrealised gains as the tax rate on long-term capital gains on both listed and unlisted securities is 12.5% instead of 10% and that on short-term capital gains on listed securities (where Securities Transaction Tax is paid) is 20% instead of 15%.

Nonresidents taxpayer also may wish to consider the amnesty scheme to settle any pending litigation, particularly if they have taken a position on claiming tax treaty benefits using a Most Favoured Nation clause, which was overturned by a recent Supreme Court decision (for prior coverage, see the article in the November 2023 issue of Corporate Tax News).

Although the budget seems to be positive for nonresident investors, it would have been much appreciated if included a roadmap on the introduction of the Pillar Two rules. However, the Finance Minister mentioned in the post-budget conference that elimination of EL 2.0 is a step in the direction of the implementation of the BEPS Two Pillar framework.
 

Source:- BDO Global