Changing Tax Landscape In India - SKP Group€¦ · LLP in India 18-07-2017 12 Hybrid entity - features of body corporate as well as traditional partnership firm LLP can be formed

Winner of India Tax Firm of the Year 2016 at the Asia Tax Awards

Changing Tax Landscape In India13 July 2017

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Major Developments

Limitation of Interest Deduction

Limited Liability Partnership

General Anti-Avoidance Rules

Income Computation and Disclosure Standards

Contents

218-07-2017

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Major Developments

318-07-2017

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Simplification of revenue audits

Limited scrutiny

Digitisation – E-scrutiny

Detailed guidelines for selection of cases of Transfer Pricing (TP) Revenue Audit

Rationalisation of safe harbour rules under Transfer Pricing

Quick disposal of Advance Pricing Agreement (APA)

Consultative approach – implementation of circular, rules, etc. after inviting public suggestions

Implementation of Goods and Services Tax (GST)

Major Developments

418-07-2017

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Enactment of Comprehensive Laws

The Black Money (Undisclosed Foreign Income and Assets) Act 2015

Benami Property Act 2016

Income Declaration Scheme 2016

Demonetisation

Scrutiny of cash deposits

Project Operation Clean Money

Signing FATCA and CRS agreements and other strict reporting requirements for certain transaction

Amendment of certain provisions – sections 10(38), 269ST, 40(A)(3) and 80G of the Act for curbing cash transactions

Integrating tax laws with global practices

Adopting BEPS Action Plan and Signing of MLI

Changes in domestic laws in line with BEPS – Patent Box Regime, County by Country Reporting, Equalisation Levy, etc.

Curbing Black Money, BEPS and Cash Economy

518-07-2017

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A situation in which a company is financed through a relatively higher level of debt compared to equity

Various countries have made rules to curb this practise. However, this was still not effective for curbing BEPS

Prior to Finance Act, 2017 - no specific provision to limit interest deductions except under Transfer Pricing

Bombay High Court in case of Besix Kier Dabhol – interest payment to AE on debt cannot be disallowed

No specific provision for re-characterisation of debt to equity under the domestic laws

No re-characterisation of debt to equity possible as it will result in non-discrimination envisaged in Article 24 of the DTAA

Thin Capitalisation | Legislative History

618-07-2017

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Action Plan 4 – Recommendations

Fixed Ratio Rule

Limit the net interest deductions to a fixed proportion (i.e. 10-30%) of EBITDA in a territory

Recommends factors to be taken into account for setting the ratio (i.e. 10-30%)

Group Ratio Rule

Offers relief to companies in groups that are highly leveraged

Allows for deduction higher than fixed ratio rule – based on relevant financial ratio of its worldwide group

Permits deduction of net interest expense up to the net third party interest expense/EBITDA ratio of its group

BEPS Action Plan 4 | Limiting Interest Deduction

718-07-2017

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Section 94B introduced – applicable from AY 2018-19

Applicability: Indian companies and Indian Permanent Establishment (PE) of foreign entities

Not applicable to companies engaged in banking and insurance

Restricts deduction in respect of expenditure by interest or of similar nature paid to non-resident associated entities to 30% of EBITDA (earnings before interest, taxes, depreciation and amortisation)

Threshold Limit: interest expenditure exceeds INR 10 million

Interest over the 30% limit could be carried forward and set off for up to 8 subsequent years

Also covers amount lent by non-AE if AE either provides an implicit or explicit guarantee or deposits a corresponding and matching amount with lender

Action Plan 4 | India’s Perspective

818-07-2017

India has considered most of the recommendations provided under BEPS Action Plan

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Particulars Scenario 1 Scenario 2 Scenario 3 Scenario 4

EBITDA 100 100 100 -100

30% of EBITDA (a) 30 30 30 NA

Interest paid to AE (b) 15 20 20 10

Interest paid to non-AE (c) 25 40 10 10

Total interest paid (d=b+c) 40 60 30 20

Total interest in excess of 30% of EBITDA (e=d-a)

10 30 0 20

Excess interest to be disallowed and carried forward(Lower of b or e)

10 20 0 10

Computation Mechanism of Disallowance

918-07-2017

Set-off of excess interest – whether treatment same as un-absorbed depreciation or carried forward loss?

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Effect on debt push-down strategies

Key terms not defined - ‘implicit guarantee’ and interest of ‘similar nature’ – open for litigation

The limit of INR 10 million is in aggregate for interest and other similar consideration

Processing fees and other upfront charges would be included in calculating limit of INR 10 million

Disallowance of expenses of “similar nature” not provided for

Bank loan exceeding guarantee amount given by AE – whether implicit guarantee?

Capitalisation of interest includible in total interest

Double disallowance possible – Transfer Pricing and 94B?

No relaxation on withholding tax obligation

Whether non-discrimination article can be invoked?

Practical Challenges and Open Issues

1018-07-2017

Internal and external debt may requires reconsideration/restructuring

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Limited Liability Partnership

1118-07-2017

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LLP in India

1218-07-2017

Hybrid entity - features of body corporate as well as traditional partnership firm

LLP can be formed either by:

Registering new LLP; or

Converting an existing partnership firm or an existing private or unlisted company

Salient features:

Minimum 2 Partners, no limit on maximum number of partners

Body Corporate

Perpetual Succession

Separate Legal Entity from its partners

Common Seal

Limited liability of Partners

Governed by LLP Agreement

Two designated partners – responsible to undertake compliance under the LLP Act

Who can be a Partner in LLP?

Individual

Body Corporate

Foreign Company

LLP (including LLP incorporated outside India)

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Tax Aspects of LLP in India

1318-07-2017

Taxation of LLP similar to partnership firm (definition of partnership firm modified to include ‘LLP’)

Residential status for income tax purposes – resident if control and management wholly or partly in India

Profits taxed in the hands of LLP @ 30% plus applicable surcharge and cess – 3 % (surcharge -12% if income > INR 10 million)

Share of profit exempt in hands of partner [section 10(2A) of the Act] – taxability in home country to be analysed in case of Foreign Partner

Remuneration to working partners and interest payment to partners deductible within limits prescribed

Taxable in the hands of the partners at slab rates applicable

Conversion of company/firm to LLP - LLP can carry forward unabsorbed depreciations and business losses

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Tax Aspects of LLP in India

1418-07-2017

Transfer of LLP interest by partner to attract capital gains tax - No taxability in case of Foreign Partners, depending on relevant tax treaty

Conversion of a private or an unlisted company to LLP is tax neutral subject to fulfilment of certain conditions

Dividend Distribution Tax (DDT)/Minimum Alternate Tax (MAT)/Buy-Back Tax (BBT) provisions not applicable to LLP

Provision relating to deemed dividend – not applicable

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Comparison | Company v/s LLP

1518-07-2017

Particulars Limited Liability Partnership Company Remarks

Legal entity Separate Entity Separate Entity Similar to Company

Perpetual succession Yes Yes Similar to Company

Liability of Partners/Shareholders Limited Limited Similar to Company

Compliances Moderate High Better than Company

Taxation Less Complex More Complex Better than Company

DDT/BBT/MAT Not Applicable Applicable Better than Company

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Conversion of private / unlisted company into LLP made tax neutral in hands of LLP and shareholders, subject to stipulated conditions:

All assets and liabilities of company to become that of LLP

All shareholders to become partners in LLP with capital contribution and profit sharing ratio in the proportion of shareholding

Shareholders not to receive any consideration or benefit, directly/ indirectly, in any form except by way of share in profit and capital contribution in LLP

Aggregate of profit sharing ratio of the shareholders of company in LLP - 50% for a period of 5 years

Sales, turnover or gross receipts in business of company in any of past 3 years < INR 6 million

Total value of assets appearing in books of accounts in any of past 3 years < INR 50 million

No direct/indirect payment to any partner out of accumulated profits of company for a period of 3 years post conversion date

Conversion of Private/Unlisted Company into LLP

1618-07-2017

Whether conversion can still be tax neutral if the above mentioned conditions especially about the turnover limit are not satisfied?

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LLP Structures

1718-07-2017

Foreign Company

Indian WOS Indian LLP

Converted or slump sale or itemised

sale

Dividend taxable @ 20.36% Tax free

repatriation of profits

Foreign Company

Indian WOS

Dividend taxable @ 20.36%

Loan – Deemed dividend

Indian LLP

Tax free repatriation of

profits

Loan – No Deemed dividend

Existing

Proposed

Indian WOS

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Who Can Invest?

A person resident outside India or an entity incorporated outside India are permitted to invest in LLP

Exceptions

a citizen/entity of Pakistan and Bangladesh

a SEBI registered Foreign Institutional Investor (FII) or

a SEBI registered Foreign Venture Capital Investor (FVCI) or

a SEBI registered Foreign Portfolio Investor (FPI)

Eligibility of LLP for accepting FDI

Existing or new LLP, operating in sectors/activities where 100% FDI is allowed under automatic route eligible to receive FDI

Exceptions

FDI-linked performance related conditions (minimum capitalization, lock-in period – NBFC, construction);

Sectors which are prohibited (atomic energy, real estate, railways);

Sectors which are restricted with caps (cable networks, petroleum refining); and

Sectors which are under the FIPB approval route (defence)

Scheme for FDI in LLP

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Ease of Introduction of Capital and Repatriation of Capital/Profits

Capital contribution/repatriation of capital/profits – normal banking channels or debit/credit to NRE/FCNR(B) account

No tax on distributions made to the partners

Pricing guidelines to be followed

Scheme for FDI in LLP

1918-07-2017

Currently ECB may not work for LLP

Availing External Commercial Borrowing (ECB)

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Operational flexibility

Less compliance compared to company – no compulsory annual general meetings, requirement of minimum capital

Conversion of private/unlisted company into LLP tax neutral

DDT/MAT/BBT provisions not applicable to LLP

Provisions relating to deemed dividend not applicable to LLP

Benefit to carry forward accumulated loss and unabsorbed depreciation for a further period of eight years

The effect of participation exemption in the home country – to be evaluated

Why LLP?

2018-07-2017

Suitable for small and medium enterprises

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General Anti-Avoidance Rules

2118-07-2017

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Applicability: FY 2017-18

Basic Provisions

2218-07-2017

Main purpose of arrangement is to obtain a tax benefit

AND

Not at arm’s-length

Misuse/Abuse of tax provisions

Lacks Commercial substance

Lack of Bona-fide purposeOR OR OR

Consequences of Impermissible Avoidance Arrangement

Disregard / Re-characterise/ Combine

arrangement / accommodating party

and connected persons

Disregard corporate structure

Deny Treaty Benefit

Re-allocate expenses,

income, relief, etc.

Re-characterize equity-debt,

expenses, income, relief,

etc.

Re-assign place of

residence/ situs of assets or transaction

Tax Benefit defined to cover reduction / deferral of tax under provisions of the Act or as a result of tax treaty

Consequences:

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Tax benefit in aggregate to all parties does not exceed INR 30 million during the year

Foreign Portfolio Investor(FPI)

Who is an assessee under the Act

Tax treaty benefit not availed

Investment in listed or unlisted securities with prior permission of competent authority

Non Resident – Investment through offshore derivative instruments or otherwise directly or indirectly in FPI

Grandfathering of investments made before 1st April 2017

However, grandfathering would not apply to tax benefit obtained from “arrangement” even when entered into before 1st April 2017

Basic Provisions | Exceptions

2318-07-2017

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GAAR Administration

2418-07-2017

Tax OfficerPrincipal

Commissioner / Commissioner

Make a reference for invoking GAAR

Assessee

Issue notice + reasons /

basisCommissioner to

issue directions as he deems fit

Objections not filed within 60

days

Objections filed within 60 days and accepted by

Commissioner

Objections filed within 60 days but not accepted by

Commissioner

Commissioner to pass an order

Commissioner to make a reference to

Approving Panel

Tax Officer and Assessee

Issue directions within a period of six months after

giving opportunity to assessee

Direct to not to invoke GAAR

Issue directions as he deems fit

AssesseeProceed to complete

assessment with approval of

Commissioner

after providing an opportunity to the

assessee

ITATPrefer an appeal

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Case Studies | Invocation of GAAR

Case Study 1 – Main purpose test A Ltd, B Ltd and C Ltd pool their resources and form a

SPV N Ltd in country F which has a provision ofresidence based taxation of capital gains in its taxtreaty with India

N Ltd invests the funds in equities in India and earnscapital gains

N Ltd contends that Country F has been chosenconsidering low cost of compliance and treatynetwork which protects investments and saves taxes

Whether GAAR can be invoked?

2518-07-2017

A LtdCountry X

B LtdCountry Y

C LtdCountry Z

N LtdCountry F

Indian company

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Case Studies - Invocation of GAAR

Case Study 2 – Arm’s length pricing A Ltd enters into a composite agreement with Indian

company (unrelated party) for setting up a powerplant in India. Contract comprises of supply of goodsand provision of services

The agreed price for the contract is INR 100 million

Offshore design under invoiced (since taxable inIndia) and off-shore supply over invoiced (since nottaxable in India)


2618-07-2017

A Ltd

Composite contract for setting up apower plant in India

Offshore Design -Taxable

Offshore Supply –Non Taxable

Local Installation -Taxable

Indian company

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Case Studies - Invocation of GAAR

Case Study 3 – Misuse / abuse of tax provisions India –F treaty provides that gains arising from sale

of shares will be taxable in India if transferor holdsmore than 10% in Indian company

A Ltd invests in Indian company through K Ltd and LLtd each holding 9.95%. Subsequently, K Ltd and LLtd sell shares in Indian company and claim treatybenefit


2718-07-2017

Indian company

9.95%9.95%

A Ltd

K Ltd L Ltd

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BEPS Action Plan 6 GAAR

Denies Treaty Benefit – where one of the principal purpose of the transaction or arrangement is to obtain benefit

Impermissible avoidance arrangement – main purpose to obtain tax benefit

No Threshold limit Threshold limit – INR 30 Million

Deny tax treaty Benefit Disregard the entire arrangement/transaction

Tax Officer can deny benefits. No safeguards of Approving Panel

Permission of Principal Commissioner of Income Tax required to invoke GAAR

BEPS Action Plan 6 – Prevention of Treaty Abuse v/s GAAR

2818-07-2017

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Income Computation and Disclosure Standards

2918-07-2017

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Background

3018-07-2017

Central Board of Direct Taxes (CBDT) has introduced 10 ICDS applicable with effect from FY 2016 – 17 i.e. AY 2017 – 18 ICDS are additional and separate set of directions to compute taxable income ICDS provisions are contrary to fundamental principles of accounting

Impact in areas of revenue recognition, expense provisions, borrowing cost capitalisation, etc. Requires recalculation of accounting profits for tax purpose

ICDS applies only to computation of income under following heads : Profits and gains of business or profession Income from other sources

ICDS applies only to taxpayers following mercantile method of accounting Applicable to all companies irrespective of turnover or quantum of income

Non resident taxpayers (PE/Branch) may also have to comply with ICDS ICDS also applicable to foreign companies deriving income in the form of FTS and Royalty

ICDS will not affect the Books of accounts

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List of ICDS Notified

3118-07-2017

SN Coverage Corresponding AS

1 Accounting Policies AS 1

2 Valuation of Inventories AS 2

3 Construction Contracts AS 7

4 Revenue Recognition AS 9

5 Tangible Fixed Assets AS 10

6 Effects of Changes in Foreign Exchange Rates AS 11

7 Government Grants AS 12

8 Securities AS 13

9 Borrowing Costs AS 16

10 Provisions, Contingent Liabilities and Contingent Assets AS 29

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Impact on non–compliance with ICDS

Assessment in the nature of best judgment assessment

Penalty for underreporting/misreporting of income

In case of conflict between ICDS and Act, the Act shall prevail

No concept of ‘Prudence’ and ‘Materiality’ in ICDS unlike, AS – 1

Strict application of ICDS by revenue authorities will require several adjustments to be made to arrive at PGBP

Follow concept of substance over form

Corporate Taxation – Key Impact Areas

3218-07-2017

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3318-07-2017

Revenue Recognition

Service revenue contract has to be recognised on Percentage completion method

Option is provided to recognise revenue on completion contract method, if duration of the contract is of 90 days or less

Interest income and Royalties need to be recognised even when the criteria of reasonable certainty of ultimate collection is not met

Taxability of exchange difference arising on a loan borrowed on purchase of domestic asset (Section 43A applies only to imported asset) - Whether allowable under ICDS VI ?

Supreme Court judgment in case of Tata Iron and Steel Company (231 ITR 285) - This judgment was pronounced before section 43A of the Act was introduced

Construction Contract – Applicable to Construction of Assets

Retention money to be recognised as revenue

Estimated loss is not allowed as a deduction

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3418-07-2017

Any contract revenue recognized as income under the ICDS, if subsequently written off as uncollectible, the same shall be allowed as a deductible expenditure in the year in which it becomes irrecoverable

Amendment to section 36(1)(vii) of the Act by Finance Act 2015

Whether the fact of non recoverability needs to be proven?

Supreme Court decision in TRF Limited impliedly overruled?

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3518-07-2017

Prolonged duration for capitalisation of borrowing cost under ICDS

‘Ready to use’ vs ‘Put to use’

Complicated Formula to work out capitalisation of interest on general purpose borrowing

Stricter Standard for allowability of Provision for expenses – Probably Certain vs Reasonable Certain

Provision for warranty, Provision for obsolete inventory

MAT will continue to be governed by books of accounts prepared as per AS/Ind AS

Mismatch between MAT and Normal Computation likely to be widened

Accelerated income recognition ‘may’ also result in duplicated levy of tax – normal tax in the year of recognition as per ICDS and MAT in the year of recognition in books

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Interplay of Normal Tax and MAT with ICDS

3618-07-2017

ParticularsYear 1 Year 2

TotalNT MAT NT MAT

Profit Before Tax 100 100 100 100 200

Add: ICDS adjustments 80 - (80) - -

Taxable Income 180 100 20 100 200

Tax @ 30% / 20% 54 20 6 20

Tax Paid 54 20 74

37%

ICDS could result in higher cash outflow in initial years

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Our Story

3718-07-2017

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3818-07-2017

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Documents

Changing Tax Landscape In India - SKP Group€¦ · LLP in India 18-07-2017 12 Hybrid entity - features of body corporate as well as traditional partnership firm LLP can be formed