INDIAN MERCHANTS CHAMBER AMENDMENTS PROPOSED IN FINANCE BILL 2013 PANEL DISCUSSION

1. INDIAN MERCHANTS CHAMBERAMENDMENTS PROPOSED IN FINANCE BILL 2013PANEL DISCUSSION 21 March 2013 Bela Sheth Mao Country Tax Lead Shell India Markets PvtLTd

2. Contents 1. GDP and tax collections 2. Tax residency certificate (TRC) 3. Pass through status – Alternate Investment Fund (AIF) 4. Special Audit 5. Defective return

3. GDP and tax collections • Economists caution that buoyancy in revenue collection will depend on maintaining the GDP growth rate in the range of 9 – 10%. The tax GDP ratio during fiscal 2010-11 was 10.8%. • Given the budgeted estimates of GDP, there will be pressure on the tax administration to meet revenue targets through aggressive assessments

4. Tax residency certificate (TRC) • Scenario up to the Budget • Section 90(3) inserted in the Income Tax Act, 1961 (‘Act’) with effect from 1 April 2013 requiring non-residents claiming treaty relief to obtain a TRC in a prescribed format • Several judgments affirming Mauritius treaty benefits (in context of capital gains relief) based on TRC, following AzadiBachaoAndolan which affirmed Circular 789 • The CBDT issued a Notification dated 17 September 2012 specifying the format of the TRC which required certain particulars on the non-resident to be verified by the overseas Government • Some jurisdictions are issuing TRCs in the required format (Singapore; Mauritius), some are flat refusing (USA; UK), some are issuing partial TRCs (Luxembourg) • There is no clarity on what happens when the TRC is not obtained in the required format

5. Tax residency certificate (TRC) • Budget, 2013 • In the Budget announced on 28 February 2013, a new Section 90(5) is proposed to be introduced in the Finance Bill, 2013 • Its language seems to suggest that the TRC is essential but not sufficient to avail treaty benefits. Further, the amendment would be effective 1 April 2012 • No indication on what happens if the TRC is not obtained in the specified format

6. Tax residency certificate (TRC) • Post Budget clarifications • The TRC will be accepted as evidence of residency • The language of the proposed Section will be taken up for consideration in the Budget session of the Parliament • Circular 789 dated 13 April 2000 in reference to Mauritius remains in force

7. Tax residency certificate (TRC) • Implications • Capital gains derived by Mauritius residents protected, in particular short term capital gains derived by FIIs • Circular 789 and AzadiBachaoAndolan still hold good in law • However, additional information may still be called for to satisfy the ‘beneficial ownership’ test to avail treaty benefits even if the new Section is not enacted • Scrutiny likely under anti-avoidance rules even if TRCs are obtained once GAAR takes effect in April 2016 (no amendments to GAAR provisions in the Budget – treaty override still exists) • TRC assumes importance because there is a significant impact when treaty benefits are not available

8. Tax residency certificate (trc) • Implications (contd.) • Tax rate on royalty / FTS has been changed to 25% from 10% • No change in the impact of Section 206AA of the Act • Example - implications under the India – Singapore treaty Pre - Budget Post - Budget Under Section 115A of the Act Under Section 206AA of the Act Under Section 112 of the Act The table does not factor surcharge and education cess

9. Tax residency certificate (trc) • Business impact • The logistics of obtaining TRCs • They are usually issued based on calendar year where as assessments are done on a financial year – timing mismatch • Payments to non-residents are recurring, real time and often there is not enough time to obtain a timely TRC – post payment event • If jurisdictions are not issuing TRCs as required by the Indian tax authorities, the WHT impact on royalty / FTS payments with changes in Section 115A will be significant • If it is a net of tax contract, the tax impact will be 33.33% - this is a significant cost of doing business in India • Most overseas group entities to whom payments are made are ‘pooling entities’ – it may be difficult to establish ‘beneficial ownership’

10. Pass thru status – alternative investment funds • Scenario up to the Budget • On 21 May 2012 SEBI introduced guidelines for Alternative Investments Funds (AIFs) which are funds incorporated or established in India for the purpose of pooling of capital from Indian or foreign investors • These guidelines have replaced the SEBI Venture Capital Fund guidelines • AIFs regulated under these guidelines should not be covered under the SEBI Mutual Fund or Collective Investment Scheme regulations • AIFs can take the form of a trust or a company or a LLP and can operate broadly under 3 categories, and it is mandatory for them to get registered with SEBI

11. Pass thru status – alternative investment funds • Scenario up to the Budget (contd.) • Activities of AIFs • Under Section 10 (23F) of the Act, venture capital companies are exempt from tax on dividends and capital gains earned where certain specified conditions are met • Accordingly, they enjoy pass through status to the extent that tax is payable on distributions to investors

12. Pass thru status – alternative investment funds • Budget, 2013 • In the Budget announced on 28 February 2013, a new Section 10(23FD) is proposed to be introduced in the Finance Bill, 2013 where the venture capital exemption is proposed to be extended to Category I AIFs registered with SEBI • This applicable where: • The AIF is not listed • 2/3rds of its funds are invested in unlisted securities, and • Directors or related parties do not hold more than 10% equity in in invested companies • ‘Angel investor pools’ will also be covered by this exemption if they are recognised by the SEBI as Category I AIFs • Exemption not extended to Category II and III AIFs (possibly because of nature of activities)

13. Pass thru status – alternative investment funds • Implications • Qualifying income of Category I AIFs (including angel investor pools) will be exempt from tax • Depending on the nature of the fund vehicle, the distribution of income to members could be tax free, specially if the members are residents of Mauritius or Singapore which have favourable tax treaties with India • AIFs if set up as companies would not be subject to rigours of Section 56(2)(viib) • Most angel investors may not qualify for Category I AIF because the minimum contribution by members is Rs 1 crore, and most angel investors are individuals who often invest less than that • Angel investors provide small amounts of capital at the start-up stage while venture capitalists enter later in the cycle. By raising minimum investment threholds and offering preferential treatment to pools, the Budget may induce angels to behave like venture capitalists and reduce access to capital for very small start-ups

14. Special audit – section 142(2A) • The Section provides that having regard to the ‘nature and complexity’ of the accounts of an assesseeand the interests of the revenue, the Assessing Officer (AO) may with the permission of the Chief Commissioner or Commissioner, direct the assessee to have the accounts audited • The expression ‘nature and complexity’ of accounts and thereby the power of the AO to direct the audit has been the subject of different interpretation by various Courts • The Supreme Court in Sahara India (Firm) v. CIT 169 Taxman 328 held that • The word complexity is not defined in the Act • It is a nebulous word • It relied on its dictionary meaning • All that is difficult to understand cannot be regarded as complex. Objectivity has to be applied. • There has to be a genuine and honest attempt by the AO to understand the accounts and AO cannot use the provision to shift the responsibility to the auditor

15. Special audit – section 142(2A) • In Delhi Development Authority v. Union of India (25 Taxman 234) the Delhi High Court held that accounts do not become complex merely because there are a large number of entries. • In V. VishnudasKini v. DCIT (109 Taxman 15) the Kerala High Court justified the special audit as gross receipt were more than Rs 2 crores, volume of vouchers were large, and correctness of expenses could not be verified without significant effort. • In ATS Infrastructure Ltd v ACIT (30 Taxman 361) the Allahabad High Court confirmed the special audit as the assessee had opted for a dubious method of accounting. • In view of the divergent views, possibly to reduce litigation and bring clarity, the powers of the AO to direct the special audit have been widened.

16. Special audit – section 142(2A) • The AO can now order a special audit not only due to the reason of nature and complexity of accounts, but also in the following additional circumstances: • The Volume of accounts • Doubts over correctness of accounts • Multiplicity of transactions in the accounts • Specialised nature of business activity of the assessee • It is evident that some of the amendments have been inserted to counter some of the judgements that have been passed in favour of assessees • The amendments significantly broaden the power of the AO without defining the scope within which the powers can be exercised. This may not reduce the probable purpose of reducing litigation.

17. Special audit – section 142(2A) • A corresponding amendment is also proposed in Section 153 in respect of period of the special audit to be excluded from the period of limitation for completion of assessment and re-assessments • The amendment provides that the period to be excluded shall be: • The period commencing from the date on which the AO directs the assessee to get his accounts audited under Section 142(2A); and • ending with the last date on which the assessee is required to furnish a report of such an audit under that Section; or • Where such direction is challenged before a Court, ending with the date on which the order setting aside such direction is received by the Commissioner

18. Defective return – section 139(9) • The Explanation to Section 139(9) provides nine conditions which are required to be fulfilled for an AO not to regard a return of income as defective • The Finance Bill, 2013 proposes to insert a new clause with effect from 1 June 2013 stating that the return will be regarded as defective if self assessment tax (along with interest) has not been paid on or before the due date of furnishing of the return • The memorandum explaining the proposed amendment states that this amendment has been proposed because it has been noticed that a large number of assessees are filing their income tax returns without payment of self assessment tax • The amendment seems to be aimed at individual assessees

19. Defective return – section 139(9) • In the context of non-resident corporate assessees, this situation is likely to arise when: • There may be uncertainty on the taxability on Indian source of their income (usually whether activities constitute a PE or not) • adequate WHT has not been withheld and deposited from Indian source taxable income, and the due date for last instalment of advance tax has passed • the due date of filing the income tax return is near