Padding up for FY18

Corporate India will have to prepare for some key and tax regulatory changes in new financial year

Going beyond the roll-out of the Goods and Services Tax (GST), experts share insights on some key tax and regulatory changes that corporate India will have to prepare for in the new financial year.

General anti-avoidance rule (GAAR) 

Change: GAAR kicks in from April 1.  It gives wide powers to tax authorities to disregard transactions or re-characterise income, if the transactions lack commercial substance.

Impact: This marks the beginning of the end of aggressive tax planning or engaging in only “tax-motivated” transactions. 

“Taxpayers should brace for additional scrutiny from tax authorities on the commercial justification for their transactions,” said Shefali Goradia, partner, BMR & Associates.

Tax experts said going forward companies should establish a firm discipline on maintaining appropriate documentation that can be helpful in explaining the business rationale for every step in a transaction. “GAAR will be looked at with trepidation by foreign investors,” said Rakesh Nangia, managing partner, Nangia & Co. Though the lawmakers have put in place certain checks and balances to avoid abuses of the rules by tax authorities, its application in practice will be closely watched, he added.

Another area of concern for foreign investors will be the adoption of the multilateral instruments (MLIs), recently released by the Organisation for Economic Co-operation and Development (OECED) as part of its project on base erosion profit shifting (BEPS). MLIs seek to put in place business purpose tests for denial of treaty benefits.

Thin-capitalisation rules 

(Interest deduction limitation)

Change: In line with the global BEPS handshake, India has introduced interest expense limitation rules on related party borrowings. Thin-capitalisation rules provide for disallowance of interest paid to associated enterprises, if it exceeds 30 per cent of the earnings before interest, tax, depreciation and amortisation (Ebidta) of the company in any given year.

Impact: From April 1, interest expense deduction of an Indian entity or a permanent establishment of a foreign entity in India is to be restricted to 30 per cent of its Ebitda, if the interest paid to related parties exceeds Rs 1 crore.

“Though there are provisions in respect of the carry forward of the disallowed excess interest, it may prove to be a challenge for the debt investment in infrastructure and real estate,” said Nangia. For industries that are cyclical in nature, interest disallowance dependent on Ebdita might pose further difficulties, said experts. To complicate matters, related-party borrowers include those unrelated lenders who have been provided an implicit or explicit guarantee or matching funds by the former, said out Garima Pande, corporate tax leader, EY India. 

This is likely to impact capital-intensive sectors, particularly those involving disproportionately high debt vis-à-vis earnings, she added.

Widening the scope of gift tax

Change: The Finance Bill 2017 has expanded the scope of taxation of receipt of money or property, without consideration or inadequate consideration. Receipt of shares of widely held companies and foreign companies is now part of the expanded ambit. However, specific exemptions have been provided for corporate restructuring, including tax-neutral amalgamations and demergers.

Impact: “Under this provision, such receipts by any person from any other person were proposed to be taxed in the hands of recipient, as against earlier legal provision covering only individuals, Hindu Undivided Family (HUF) , and, in some cases, firms and companies,” said Partho Dasgupta, partner, direct tax, BDO India.

Tax experts pointed out another anti-abuse measure that comes into effect from April is the notional capital gains taxation at fair market value on transfer of unquoted shares. 

This applies to transfers that are below the fair market value. However, the manner of determining fair market value is yet to be prescribed. 

“These two provisions are likely to have significant impact on business and ownership reorganisations that are implemented after April 1, 2017,” said Pande.

Amendments in the Double Tax Avoidance Agreement (DTAA) with Mauritius, Singapore & Cyprus  

Change: Capital gains on transfer of shares of an Indian company after April 1by a resident of Mauritius, Singapore and Cyprus will be taxable in India. Shares acquired till March 31 have been grandfathered, subject to compliance with limitation of benefit (LOB) rules specified under the respective tax treaties. This means the old provision will continue.

For new investments, there is a phased withdrawal of the capital gains tax exemption, subject to certain conditions. 

Impact: “Foreign investors from these countries should review their structures in light of limitation conditions provided in the treaty,” said Goradia of BMR and Associates.  

Experts said every structure will need to satisfy the substance requirement and should be set up primarily for non-tax reason. “This should be sufficiently reflected in the conduct of the affairs of the companies,” she said.

Lapse of Bilateral Investment Treaties (BITs)

Change: In response to the large number of claims brought against India under the various bilateral investment treaties, the government unilaterally issued BIT termination notices to around 55 countries in 2016. This included the United Kingdom, Germany, France, Netherlands, and UAE, among others. The one-year notice period expired in March for several countries. 

Impact: Starting April 1, any new investment from these jurisdictions or Indian investments into these jurisdictions will not be protected under the provisions of BITs, said Rishab Gupta, counsel, Shardul Amarchand Mangaldas. However, existing investments to or from these jurisdictions will continue to remain protected for a period of 10-15 years, by virtue of the so-called ‘sunset clauses’, experts said. 

BITs protect investments against political risks, the risk of expropriation or sudden adverse regulatory changes. “Termination of BITs is likely to force foreign investors (or Indian investor investing abroad) to consider other ways to protect their investments,” says Gupta. That could include buying political risk insurance or routing investments via jurisdictions with which India still has BITs. Tax experts point out that in order to remain an attractive investment destination, India should consider replacing the terminated BITs with new treaties at the earliest possible.