Indian 2014 budget: A tax perspective for the global investor
TAX ALERT |
The maiden budget presented by Indian Prime Minister Narendra Modi's new government was highly anticipated to put India back on the development path and attract global investment, which has been, for the recent past, hesitant at best. This hesitancy has stemmed from various political and economic factors, including certain pieces of "entitlement legislation," such as retroactive tax amendments (discussed further below). The immediate challenge for the new government was to introduce bold economic and tax reforms to improve the investment climate and clarify the muddled tax environment.
While the budget presented in the Indian parliament on July 10, 2014, targets economic growth, it falls short of any bold economic or tax reforms. Overall, it is a moderately positive budget that focuses on increasing investment, improving infrastructure and reviving the manufacturing sector. While investors waiting for the right signal to proceed with investments into India should be encouraged by the government intentions represented within the budget, the budget offers no specific measures to encourage investment. In the budget, the new government acknowledges investors' most significant concerns (e.g., transfer pricing and the retroactive taxation of indirect share transfers, discussed later). This article discusses some of the key issues of importance to global investors and the way in which the Indian government addresses these issues in the Union Budget of India for 2014-5 (Budget 2014).1
Retroactive tax amendments
Retroactive tax amendments were introduced in the Union Budget of India for 2012-2013 (Budget 2012) to reverse the pro-taxpayer decision of the Supreme Court in the Vodafone case. The primary issue in Vodafone was whether India had jurisdiction to tax the indirect transfer of shares of an Indian company between two non-Indian companies.2 The Indian taxing authorities attempted to impose a US $2.5 billion withholding tax liability on Vodafone on the theory that since the transfer of stock involved an indirect interest in an Indian company, India had jurisdiction to tax the gain from the transaction. The Indian Supreme Court overruled this decision, ruling that Indian tax laws did not provide the jurisdiction to tax these gains. Budget 2012 not only attempted to overrule the Vodafone decision, it sought to retroactively amend Indian tax law to clarify that these indirect transfers have always been taxable and, thus, provide the authority to tax the Vodafone transaction ex post facto.
This proposal in Budget 2012 understandably unsettled investors since it demonstrated India's inability to provide certainty regarding the tax consequences of their investments. The potential for adverse retroactive legislation coupled with aggressive enforcement of transfer pricing (discussed later) have discouraged foreign investment. In its pre-election party manifesto, the new pro-business government referred to the party's intention to do away with "tax terrorism." As a result, enormous expectations built up in the market that the retroactive amendment introduced by Budget 2012 would be repealed. Though Budget 2014 did not repeal this amendment, the Indian finance minister announced that all cases of indirect transfers arising out of retroactive amendments will be scrutinized by a high-level committee of the Central Board of Direct Taxes (CBDT) before initiating any action. He also announced that the government, in the future, will not ordinarily initiate retroactive amendments. While this definitely falls short of the clarity and relief investors expected, it is reasonable to expect that, in the coming months, the government will take a close look at this issue and provide more specific measures and timelines. There is a significant expectation that this policy or intention will be translated into action.
To call India's enforcement of transfer pricing laws aggressive would be an understatement. Transfer pricing disputes with Shell, Vodafone and other multinational companies have made headlines, mostly for the absence of merit in the arguments put forth by tax authorities. Transfer pricing adjustments increased from US $275 million in 2008 to US $8,900 million in 2012. Based on these activities, one could argue that the Indian tax authorities feel they are entitled to a larger share of a multinational's profit than global transfer pricing standards would generally support.
No doubt, transfer pricing is an area where clarity, certainty and changes to enforcement would be welcome. While investors must wait to see if transfer pricing enforcement policy will change, they certainly expected some clarity on the transfer pricing rules. The finance minister acknowledged that transfer pricing was an area of extensive litigation but stopped short of announcing any significant changes to the regime. However, Budget 2014 introduced certain amendments to better align Indian transfer pricing rules with global standards. Specifically, these include:
Introduction of the concept of an arm's length range. Under global transfer pricing principles, a taxpayer will be considered to meet the arm's length standard if the intercompany transaction results are within the "range" of results exhibited by comparable companies. Under this approach, the taxpayer's results are tested against a range rather than a single price/margin, thereby providing more flexibility. Indian regulations hitherto provided only for a single point and not a range. Globally standards typically apply an arm's length range, and the introduction of a range by Budget 2014 aligns the Indian rules to global transfer pricing standards and at the same time provides taxpayers more flexibility in determining transfer prices.
Acceptability of multiple-year comparable data. In order to explain a taxpayer's transfer prices, multiple economic factors are considered, including the industry in which the taxpayer operates. This more often than not requires an analysis of the industry performance over a period of three to five years in order to capture economic cycles and fluctuations. Under global standards, a multiple-year average is generally acceptable, and by introducing the acceptability of multiple-year data, Budget 2014 will align Indian transfer pricing rules with global practices and provide relief to taxpayers.
Advance Pricing Agreement (APA) rollback provision. An APA is a mechanism that enables the taxpayer and tax authorities to agree on the taxpayer's transfer pricing method prior to the taxpayer entering into the transaction. Under current Indian law, an APA agreement provides taxpayers certainty for a term of three to five years. Budget 2014 has introduced rollback provisions under which the taxpayer and Indian APA authorities can apply the methodology contained in the APA to the prior four tax years. This provision will help resolve a significant amount of pending transfer pricing litigation.
Goods and Sales Tax (GST)
India levies multiple layers of indirect taxes, including central sales tax, state sales tax, entry tax and other levies. There is a critical need to streamline these multiple taxes. The GST reform contained in Budget 2014 substitutes a comprehensive (single) national tax levy for all indirect taxes imposed on the manufacture, sale and consumption of goods. Through a tax credit mechanism, this tax will be collected on value-added goods and services at each stage of sale or purchase throughout the supply chain.
This important GST reform has developed over the course of several years and the new GST proposal contained in Budget 2014 should streamline tax administration and ensure higher revenue collection. The minister hopes to approve the legislative scheme in the course of the year, which would enable introduction of the GST.
Budget 2014 also addresses the inverted duty structure for specified sectors, rationalization of duty rates, and exemptions for services. The tax base for the services tax has been broadened to include services such as advertisement on online media, while exemptions for certain services such as drug testing on human participants have been withdrawn.
India hopes to reduce its widening fiscal deficit to an ambitious level of 4.1 percent of gross domestic product (GDP) and also achieve a growth target of 7 – 8 percent. Foreign investment and higher tax-to-GDP ratios are crucial to achieving fiscal consolidation. While the Indian government has demonstrated a clear intent to streamline the tax environment, it remains to be seen if this desire will be supported by concrete proposals, timelines and effective action. This is a nascent government subject to the high expectations of domestic and global investors, who have been waiting a long time for improvements in the Indian tax and investment environment.
1 Indian tax years commence on April 1.
2 In 2007, Vodafone's Dutch subsidiary acquired the stock of a Cayman Islands company from a subsidiary of Hutchinson Telecommunications International Ltd. (the subsidiary was also located in the Cayman Islands). The Cayman company acquired by Vodafone owned an indirect interest in Hutchinson Essar Ltd. (an Indian company) through several tiers of Mauritius and Indian companies.