BUDGET 2021 having taken place in exceptional times, a lot was expected from it, particularly from the point of view of mobilising additional revenue to support the expected additional expenditure plan of the Government of India. The OXFAM inequality report published just a few days back, added extra poignancy in the debate by pointing out that the pandemic has exacerbated inequality in societies, making the rich immensely richer while at the same time increasing poverty at the lower segments of the population. This is a phenomenon noticed all over the world including in India. Some countries have indeed levied extraordinary taxes to deal with the extraordinary situation. Most notable is the case of Argentina, where a one-time wealth tax has been levied on anyone having assets in excess of a particular limit. There was speculation about such a move even in India considering that the incidence of taxes on capital is decreasing while increasing the same on labour and consumption. Naturally, therefore there was some nervousness on the part of the footloose foreign portfolio investors who sold heavily Indian stocks for a few days preceding the budget.

The FM in her budget speech, surprised many by leaving all the headline tax rates alone. There was no imposition of any additional COVID or any other surcharge (except for a bit on the customs side). Having reduced the corporate taxes only a year earlier, it would have been difficult to increase the same, particularly when the strategy of the government seems to bet on the tax rate reduction inspired investment expected from foreign investors who intended to relocate their supply chain away from China. The Economic Survey had already laid out this philosophy by making an interesting distinction between inequality and poverty and also by distinguishing the Indian situation from that of the developed economies. The survey asserted that unlike the conflict between growth and inequality witnessed in the developed economies, in India, inequality and growth converge in their effects on various indicators such as health, etc. The Survey concluded that for a developing country such as India, where the growth potential is high and the scope for poverty reduction is also significant, a policy that lifts the poor out of poverty by expanding the overall pie is preferable as redistribution is only feasible if the size of the economic pie grows rapidly. In other words, the much maligned trickledown effect actually works. Ironically, the Survey gives the example of China in coming to this conclusion.

This fiscal strategy is appealing to many in India while greater number of economists would like to rely more on welfare spending through taxation. Whether such a strategy would finally succeed in the long run, one has to wait and see. In the meantime, the stock market that is accessible to relatively few in the Indian context has given a big thumbs up to the stock market with the Sensex again crossing the 50000 mark.

Both the speech of the Finance Minister and the content of the Finance Bill were shorter than the norm that has come to be associated with this annual exercise. As many commentators have pointed out that the best part of the budget was what was not there in it and could have been, namely increase in taxes. The fine print however does contain some disturbing elements from the point of view of international taxation but these do not impinge on the hoi-polloi and has not therefore elicited much response. In so far as non-resident taxation is concerned, in her main budget speech, the Finance Minister mentioned about the difficulties faced by returning non-resident Indian in respect of their accrued income earned abroad and proposed to introduce rules to remove their hardship. The other measure relates to the application of the treaty rate rather than the domestic tax rate on remittance of income to FPIs. She also talked about relaxing some of these conditions relating to prohibition on private funding, restriction on commercial activities, and direct investment in infrastructure in respect of sovereign wealth funds and pension funds investing in the infrastructure sector, who were already granted tax exemption in the earlier budget. Of course, there was the mandatory further incentives to the GIFT City in the form of exemption for aircraft lease rentals paid to foreign lessors; tax incentive for relocating foreign funds in the IFSC; and to allow tax exemption to the investment division of foreign banks located in the IFSC.

None of these proposals was really headline material. However, the Annex-VI of the budget speech, which was not read out, did contain some surprises. These were the changes proposed in Equalisation levy to apparently clarify regarding applicability of the levy on physical/offline supply of goods and services; the abolition of the Authority of Advance Ruling and its substitution by a Board whose orders would be appealable and to define the term 'liable to tax' to provide certainty. All these changes are very substantial in nature and affect the non-resident taxation in more profound ways and are being discussed in detail here.

'Liable to tax'

In order to boost investment by foreign pension funds in India, Budget 2020 had introduced section10 (23FE) as follows:

any income of a specified person in the nature of dividend, interest or long-term capital gains arising from an investment made by it in India, whether in the form of debt or share capital or unit, if the investment-

(i) is made on or after the 1st day of April, 2020 but on or before the 31st day of March, 2024;

(ii) is held for at least three years; and

(iii) is in-

(c) a pension fund, which-

(i) is created or established under the law of a foreign country including the laws made by any of its political constituents being a province, State or local body, by whatever name called;

(ii) is not liable to tax in such foreign country;

(iii) satisfies such other conditions as may be prescribed; and

(iv) is specified by the Central Government, by notification in the Official Gazette, for this purpose and fulfils conditions specified in such notification.

Subsequently, the CBDT issued Notification No 67/2020 containing Rule 2DB prescribing certain conditions including a certification by an Indian CA to the effect that the Pension Fund is in compliance with the provisions of Section 10(23FE) read with the said Rule 2DB.

The Finance Bill, 2021 now proposes to add a definition to the term 'liable to tax' in the ITA as follows:

Section 2(29A): "liable to tax", in relation to a person, means that there is a liability of tax on such person under any law for the time being in force in any country, and shall include a case where subsequent to imposition of tax liability, an exemption has been provided

As I understand it, this means that if a Pension Fund is otherwise taxable in the home country, but gets an exemption by virtue of some special provision, then also the pension fund will be considered as liable to tax in that country . That is indeed the normal meaning of the term in the treaty context. But, once it is 'liable to tax' in the home country, it loses the benefit under section 10(23)(FE) as it stands today.

Under the rubric - 'Rationalisation of provisions related to Sovereign Wealth Fund (SWF) and Pension Fund (PF)', the Memorandum explains that presently, some Pension Funds are liable to tax in their country though given exemption subsequently. It has therefore been proposed to amend this sub-clause to provide that if a pension fund is liable to tax but exemption from taxation for all its income has been provided by the foreign country under whose laws it is created or established, then such pension fund shall also be eligible.

But to be eligible, the Pension Fund must not be liable to tax in the home country in terms of Section10 (23)(FE). So, there seems to be a mismatch between the intention and the draft legislation.

At another place, the Memo explains as follows:

"The Act currently does not define the term ?liable to tax though this term is used in section 6, in clause (23FE) of section 10 and various agreements entered into under section 90 or section 90A of the Act. Hence, it is proposed to insert clause (29A) to section 2 of the Act providing its definition. The term? liable to tax in relation to a person means that there is a liability of tax on that person under the law of any country and will include a case where subsequent to imposition of such tax liability, an exemption has been provided."

In the context of the eligibility of the tax treaty benefits, from the point of view of the taxpayers this is welcome although such a generous view is not always taken by many other countries.

From the point of view of the determination of residence under section 6 also, the definition will put an end to the controversy regarding the availability of the benefits to Indian citizens resident in jurisdictions that charge income to tax but because of exemptions/deductions, there is no liability to tax. But, such Indian residents will now become resident but not ordinarily resident bringing their business/professional income controlled from India to tax in India.

However, the issue as to whether the treaty benefits will be available when no tax itself is charged still remains unclear although as we have seen in the treaty with the UAE, the linkage is with the period of stay in UAE or control or management of a legal entity from the UAE, thereby skirting the debate of liability to tax.

Equalisation levy

Equalisation levy was introduced by the Finance Act, 2016. The levy became operational from June 2016. Section 165 of the Finance Act provided that the levy will be payable by a non-resident for certain specified services rendered to a resident of India carrying on business or to a non-resident having a PE in India. The charge was @6% on the consideration for certain services as specified by the government. Initially the levy was imposed in respect of online advertisement or for the provision of any digital advertisement space or any other facility or service for the provision of online advertisement. There was a safe harbour of an amount of INR 100000.

Although the levy was intentionally kept out of the Income Tax Act so as not to violate any treaty obligation, Section 10(50) of the ITA provided that any income of the non-resident under the ITA will be exempt from tax if the levy was charged. There can always be an overlap between the consideration for online advertisement or similar services and other articles, notably Royalty/FTS and any income embedded in the payment could arguably be taxed as royalty or fees for technical services. Because of section 10(50), this possibility was precluded. Besides, the withholding rate of such royalty/FTS, normally being 10% under most of the treaties, it would have been beneficial for the taxpayers to pay the levy @6% and get done with it. In fact, if I remember correctly this position was reiterated by the CBDT officials in various conferences.

Then, in the 2020 budget, a new section 165A was inserted in the Finance Act, 2016 that remains the basic legislation for the Equalisation levy and scope of the levy was extended to an e-commerce operator or on e-commerce supply and services to an Indian resident or to a non-resident having a PE in India or to a person who buys such goods or services from an internet protocol address located in India. The rate of the levy was lower in such cases at 2% of the consideration. There was a safe harbour of 2 crores. Again, the income, if any of the e-commerce operator would be exempt under section 10(50).

The Finance Bill 2021 now proposes to amend section 10(50) as follows:

"Explanation 1.--For the removal of doubts it is hereby clarified that the income referred to in this clause shall not include and shall be deemed never to have been included any income which is chargeable to tax as royalty or fees for technical services in India under this Act read with the agreement notified by the Central Government under section 90 or section 90A."

The implication of this explanation is that if the income of the non-resident is chargeable as royalty or FTS under the Act or the treaty, no equalisation levy will be charged and this is with retrospective operation. While it has been viewed favourably by Commentators, if the view is taken that EQ levy being charged at a lower rate on the consideration wherein the income embedded in the payment could represent royalty, then the provision is not beneficial to the taxpayer. Some people have linked this amendment to the action of the US trade representative in opening Section 301 investigation and confirming that Indian EQ along with French and other DSTs were discriminatory.

We may note that it is after this expansion in scope of the levy by the Finance Act, 2020 that the US Trade Representative opened the investigation under section 301 and found that the Indian Equalisation levy was discriminatory Vis-a Vis American businesses in that Indian companies were kept out of its ambit.

The main reasons of the enquiry were the following:

- India's DST, by its structure and operation, discriminates against U.S. digital companies, including due to the selection of covered services and its applicability only to non-resident companies.

- India's DST is unreasonable because it is inconsistent with principles of international taxation, including due to its application to revenue rather than income, extraterritorial application, and failure to provide tax certainty.

- India's DST burdens or restricts U.S. commerce

In its final 301 report, the USTR points out that while other countries' DSTs seek to exempt domestic companies indirectly using high revenue threshold, India's approach is more straightforward. India openly discriminates, explicitly exempting all Indian companies from the levy. Referring to an article in International Tax Review, "Discussion: Kamlesh Varshney talks about India's tax policy agenda" March 30,2020, the report says- "As one Indian government official confirmed, the very purpose of the DST is to tax foreign companies only, explaining that "(a)ll parts the digital taxation incident should be on the foreign player, because if the incidence is passed on to the Indian player, then it doesn't really serve the purpose."

The stand of the Indian government was that the Indian levy did not discriminate against US companies as it applied equally to all non-residents; that it was prospective and has no extra-territorial application.

Now, through the Budget 2021, a further amendment has been done in the Finance Act, 2016, It has been proposed to insert an Explanation to clause (cb) of section 164 of the Finance Act, 2016, providing that for the purposes of defining e-commerce supply or service, ?online sale of goods? and ? online provision of services? shall include one or more of the following activities taking place online

(a) acceptance of offer for sale; or (b) placing of purchase order; or (c) acceptance of the purchase order; or (d) payment of consideration; or (e) supply of goods or provision of services, partly or wholly;

It has also been proposed to amend section 165A of the Finance Act, 2016, to provide that consideration received or receivable from e-commerce supply or services shall include: (i) consideration for sale of goods irrespective of whether the e-commerce operator owns the goods; and(ii) consideration for provision of services irrespective of whether service is provided or facilitated by the e-commerce operator.

In effect this therefore amounts to further expanding the scope of the EQ levy. Again, we will have to wait and watch how these moves will be perceived by other countries.

AAR

The other major area from the point of view of international taxation, is the proposal to abolish the institution of the Authority of Advance Ruling and substitute the same with an inhouse ruling mechanism. The AAR as an institution was synonymous with the opening up of the Indian economy. As we are aware, the AAR was formed in the year 1993 when foreign investment was also opened up and gave the foreign investors an avenue whereby they could get a ruling in advance of their actually investing money in India. A time limit of 6 months was prescribed for the ruling and the ruling was binding both on the taxpayer and on the tax department without creating a binding precedent. The AAR functioned very well in the initial years and although faltering at times, gave many path breaking rulings relating to international tax, an area where there is not much expertise amongst the judiciary or even amongst the policy makers.

It is true that over the years, there was considerable delay in rendering the rulings and there was disaffection amongst foreign investors in this regard. However, if one analyses the issue dispassionately, it seems that the problem was more with the procedural aspect of selecting the members and more particularly of the Chairman of the AAR. Realising the potential of the AAR, late Mr Arun Jaitley in 2014 had in fact extended its ambit and a new Bench was opened in Mumbai and the post of Vice-Chairman was created. It has been stated that government found it difficult to find retired judges of the Supreme Court/ High Courts, willing to take up the assignment. When such judges are quite willing to fill up various Tribunals, there must be something wrong with the selectin process of the relevant posts. The Finance Bill proposes to substitute the AAR with a Board consisting of high level officers of the tax department and the ruling/decisions of such body will not be binding either on the taxpayer or on the tax department and will be subject matter of appeal to the High Courts.

The Indian AAR was one of a kind in that it was a judicial and adversarial process as compared to private rulings given by various other tax jurisdictions making the process rather slow. However, replacing it with an administrative body may not inspire confidence in the taxpayers in general. Besides, the AAR also functions in the area of indirect taxes. One is not sure what will happen to those situations.