India's 2017 budget contains some welcome proposals
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On Feb. 1, 2017, the India Finance Minister introduced a balanced budget focused on long-term growth and stability (Budget 2017). The budget was introduced in the midst of key domestic initiatives such as the introduction of the comprehensive goods and services tax, demonetization of large denomination currency notes to prevent tax evasion and the introduction of bankruptcy/ insolvency laws to improve the business environment and alleviate distressed credit markets. While all well intended, the implementation, enforcement and ultimate impact of these initiatives remain open questions.
The budget proposals aimed to find a balance between easing some of the demonetization pain and ensuring strict enforcement and compliance. All in all, Budget 2017 aimed to ‘transform, energize and clean India’ by introducing significant proposals regarding infrastructure and real estate sector development, start-up rationalizations and political funding limitations and providing income-tax relief for low income earners. This article, however, focuses on the key budget proposals relevant to the foreign corporate investor.
- Corporate tax rate for companies with revenues less than INR 500 million (approximately USD 7.5 million) reduced to 25 percent base rate (surcharge and additional taxes applicable that can increase effective tax rate up to 28 percent). Companies with revenues exceeding this threshold will continue to be taxed at the base rate of 30 percent.
- Thin capitalization rules have been introduced that limit interest payable by Indian companies to overseas related parties to 30 percent of the Indian company’s EBITDA. Any interest paid in excess will not be deductible but can be carried forward for a period of eight years. These provisions are in line with the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting project (specifically Action 4 – Limiting Base Erosion Involving Interest Deductions and Other Financial Payments).
- Transfer pricing related ‘secondary adjustment’ provisions are introduced to give economic effect to the primary transfer pricing adjustments made to the Indian taxpayer. Additionally, the excess cash resulting to the related party by virtue of the upward adjustment to the Indian taxpayer must be repatriated to India within a prescribed time limit. If not, the cash will be treated as an interest bearing advance to the related party. Where primary adjustments are less than INR 10,000,000 (approximately USD 150,000), these provisions do not apply.
- Capital gains related proposals
a. The 2016 budget taxed long-term capital gains recognized by a foreign company from the transfer of shares of an Indian company (not being a company in which the public is substantially interested) at 10 percent. Budget 2017 makes this applicable retroactively to April 2013.
b. Indirect transfer provisions shall not apply to investments held by non-residents in Category I (government and government-related investors) or Category II (regulated broad-based funds such as mutual funds, insurance companies, etc.) foreign portfolio investments. This is applicable retroactively to April 2012.
c. Conversion of preference shares into equity shares are not regarded as a ‘transfer’ and not subject to capital gains tax.
- To further liberalize foreign investment, the Foreign Investment Promotion Board is proposed to be abolished. Most investments are now under the automatic route where government approval may not be required, in any event.
- The Authority of Advance Rulings for income taxes and the corresponding body for custom duties and other indirect taxes will now merge to provide guidance under the customs and indirect tax laws to provide a single forum for certainty and clarity.
While the above proposals are welcome changes, a few anticipated proposals such as reduction in corporate tax rate for all companies to 25 percent, reduction in minimum alternate taxes and dispute resolution mechanisms were not introduced.
The budget proposals are designed to support the Indian government’s plans to reduce the fiscal deficit to 3 percent and set the foundation for sustainable economic growth. The administration of these provisions in an efficient manner will be critical to ensure that India remains a bright spot for the global investor.