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Budget 2023: No room for 2-Pillar Solution?
By D P Sengupta
Feb 02, 2023

I am not sure, but the Budget speech of the Finance Minister this year was perhaps the shortest in duration amongst the five presented by her. That does not mean that the Finance Bill itself is less voluminous. In fact, the Finance Bill 2023 contains 122 clauses relating to Direct taxes.

However, in so far as non-resident taxation is concerned, there are not too many fireworks. In fact, the MNCs and their spokespersons were expecting a road map for India in adopting the Inclusive Framework's two pillar solution. Even though there is no consensus as yet in the OECD regarding the paltry amount A of pillar 1 that is supposed to come to the kitty of the developing countries, the developed world, particularly the USA, is very much interested in the Pillar 2 Global Minimum Tax of 15% and both the EU and the USA have arm twisted many low tax jurisdictions into formally accepting the proposal. India, so far, seems to be a keen participant in the OECD two-pillar solution. India also has the Presidency of G-20 that, at least theoretically drives the tax agenda of the Inclusive framework.

As has been pointed out in this column time and again, the two pillar proposals are immensely complex and many scholars have questioned the suitability of proposed solution to the vexed question of solving the taxation issues arising out of digitalisation and whether the proposals are for the interest of developing countries including for India. In the context of the Pillar 2, at this stage, it may be recalled that the corporate tax rate of 15% is not the headline rate but an effective tax rate, which reduces the possibility of countries to give special incentives in the interest of attracting foreign investments or of having preferential regimes for SEZs etc. It should be remembered that the Pillar 2 proposals are mainly to be implemented via domestic legislation. Thankfully, the government has, at least till now not hurried to implement the proposal in the domestic legislation.

On the contrary, the very first proposal affecting non-resident taxation relates to some exemptions for the International Financial Centre. It is now routine for every budget to provide some further sops for the IFSC and this budget is no exception. Thus, we find that in order to further incentivize operations from IFSC, the government has proposed to provide the following:

(i) amend clause (b) of the Explanation to s. 47 (viiad) of the Act to extend the date for transfer of assets of the original fund, or of its wholly owned special purpose vehicle, to a resultant fund in case of relocation to 31st March, 2025 from current limitation of 31st March, 2023.

(ii) Income of non-residents on transfer of Offshore Derivative Instruments (ODI) entered into with IFSC Banking unit is exempt under section 10 (4E) of the Act. Under the ODI contract, the IFSC Banking Unit (IBU) makes the investments in permissible Indian Securities. Income earned by the IBU on such investments is taxed as capital gains, interest, dividend under section 115AD of the Act. After the payment of tax, the IBU passes such income to the ODI holders.

Presently, the exemption is provided only on the transfer of ODIs and not on the distribution of income to the non-resident ODI holders, hence it has been argued that this distributed income is taxed twice in India, first when received by the IBU and second, when the same income is distributed to non-resident ODI holders. Accepting the argument, it has been proposed to amend clause (4E) of section 10 of the Act, to also provide exemption to any income distributed on the offshore derivative instruments, entered into with an offshore banking unit of an International Financial Services Centre as referred to in sub-section (1A) of section 80LA, which fulfils such conditions as may be prescribed. It has also been provided that such exempted income shall include only that amount which has been charged to tax in the hands of the IFSC Banking Unit under section 115AD.

The next proposal relates to taxation of gifts. Gift tax was abolished in India in the year 1998 on the ground that it did not generate adequate revenue to justify its existence. This naturally left a huge loophole on the income tax legislation and administration. As an anti-abuse measure, in the year 2004 in a proposal for which yours truly was responsible, it was decided to introduce a provision for taxing the alleged gifts in the hands of the recipient by deeming the same as income through an amendment in the definition of income and tax the same as income from other sources under section 56. Ever since, the provision has been tightened and amended umpteen times almost through every budget. This year is no exception and the amendments proposed relate to the non-residents.

Originally, alleged gifts received by Indians from non-residents was receiving attention of the tax authorities. Subsequently, the department noticed that gifts were being made by persons residents in India to non-residents and were claimed to be non-taxable in India by such non-residents. Therefore, as an anti-abuse measure, Finance (No. 2) Act, 2019 inserted clause (viiii) to sub-section (1) of section 9 of the Act to provide that the any sum of money exceeding fifty thousand rupees, received by a non-resident without consideration from a person resident in India, on or after the 5th day of July, 2019, shall also be income deemed to accrue or arise in India.

The ingenuity of Indian taxpayers whether resident or non-resident knows no bounds. Although the Income Tax Act has two broad classification of taxpayers- residents or non-residents, there is also a sub-class of residents- 'not ordinarily resident'. This class is not non-resident for the purpose of the Act. The memorandum to the Finance Bill mentions that it has come to the notice of the tax department that certain persons being not ordinarily residents are receiving the gifts from persons resident in India and are not paying tax on it.

Accordingly, it has been proposed to amend clause (viii) of sub-section (1) of section 9 of the Act so as to extend this deeming provision to sum of money exceeding fifty thousand rupees, received by a not ordinarily resident too who receives the same without consideration from a person resident in India.

The next provision affecting the non-residents is the one relating to the special provision for computing profits and gains in connection with the business of business of providing services or facilities in connection with, or supplying plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils. This is contained in section 44BB of the Income Tax Act.

As originally enacted in 1987, the section applied to the income from such activities of both residents and non-residents. On the ground of indigenisation and preserving foreign exchange reserve, the Finance Act 1988 restricted its application to the income of only non-residents on the ground that the books of non-residents kept abroad are not easily available for verification and therefore a resumptive income of 10% of the aggregate amounts as specified in sub-section (2) of the section should simplify the compliance.

This state of affairs continued till 2003 when pursuant to the report of the working group on taxation of non-residents, it was provided that as in the case of presumptive taxation of residents, where the non-resident maintains such books of account and other documents as required under sub-section (2) of section 44AA of the Act and gets his accounts audited and furnishes a report of such audit as required under section 44AB of the Act, the non-resident may claim lower profits and gains.

Similarly, a new section 44BBB was introduced by the Finance Act, 1989 that provides for presumptive scheme in the case of a non-resident foreign company who is engaged in the business of civil construction or the business of erection of plant or machinery or testing or commissioning thereof, in connection with a turnkey power project approved by the Central Government. Under this scheme, a sum equal to ten per cent of the amount paid or payable (whether in or out of India) to the said taxpayer or to any person on his behalf on account of such civil construction, erection, testing, or commissioning is deemed to be the profits and gains of such business chargeable to tax under the head "Profits and gains of business or profession".

Here also, pursuant to the working group's report through an amendment in 2003, the taxpayer could claim lower profits and gains than the profits and gains specified if he keeps and maintains such books of account and other documents as required under sub-section (2) of section 44AA of the Act and gets his accounts audited and furnishes a report of such audit as required under section 44AB of the Act.

Now, the tax department has noticed that the said option given to the non-residents was being misused in that taxpayers opt in and opt out of presumptive scheme in order to avail benefit of both presumptive scheme income and non-presumptive income. In a year when they have loss, they claim actual loss as per the books of account and carry it forward. In a year when they have higher profits, they use presumptive scheme to restrict the profit to 10% and set off the brought forward losses from earlier years. The Memorandum clarifies that conceptually, if the taxpayer maintains books of account and claim losses as per such accounts, he should also disclose profits as per accounts and that there is no justification for setting off of losses computed as per books of account with income computed on presumptive basis.

In order to avoid such misuse, it has been proposed in the Finance Bill to insert a new sub-section to section 44BB and to section 44BBB of the Act to provide that notwithstanding anything contained in subsection (2) of section 32 ( unabsorbed depreciation) and sub-section (1) of section 72 ( unabsorbed business loss) , where a taxpayer declares profits and gains of business for any previous year in accordance with the provisions of presumptive taxation, no set off of unabsorbed depreciation and brought forward loss shall be allowed to the taxpayer for such previous year.

Apart from the above, there are two other changes that may affect the non-residents. One relates the time period for furnishing of Transfer Pricing Report by the taxpayer. It has been explained in the Memorandum to the budget that in terms of Section 92D of the Act, every person who has entered into an international transaction or a specified domestic transaction shall keep and maintain the information and documents as provided under rule 10D of the Income-tax Rules, 1962. And, as per sub-section (3) of section 92D of the Act, the Assessing Officer (AOs) or the Commissioner (Appeals) may during the course of any proceedings under the Act require such person to furnish any information or document, as provided under rule 10D of the Rules, within a period of 30 days from the date of receipt of a notice issued in this regard. It has been further provided that on an application made by the taxpayer the time period of 30 days may be extended by an additional period of 30 days.

It seems that in several instances due to limited time available for TP proceedings it might not be practically possible to provide minimum 30 days for producing these information or documents which in any case is already in possession of the taxpayer concerned. Accordingly, the time period allowed for submission of information or documents in respect of international transactions or a specified domestic transaction was required to be rationalised so as to provide the tax officers a reasonable amount of time to examine the information/documents submitted and complete the pending proceedings.

Accordingly, it has been proposed in the Finance Bill to amend sub-section (3) of section 92D of the Act to provide that,- (i) the Assessing Officer or the Commissioner (Appeals) may, in the course of any proceeding under the Act, require any person referred to in clause (i) of sub-section (1) of section 92D of the Act i.e., who has entered into an international transaction[ or specified domestic transaction], to furnish any information or document referred therein, within a period of ten days from the date of receipt of a notice issued in this regard; and (ii) the Assessing Officer or the Commissioner (Appeals) may, on an application made by such person who has entered into an international transaction or [specified domestic transaction], extend the period of ten days by a further period not exceeding thirty days.

The penultimate provision directly affecting non-residents relates to withholding. Section 196A of the Act provides for deduction of tax at source on payment of certain income to a non-resident at the rate of 20%. The income is required to be in respect of units of a Mutual Fund. Apparently, the CBDT received representations requesting that the benefit of tax treaty may be considered at the time of withholding so that if the treaty provides a rate lower than 20%, TDS is made at that lower rate.

Accepting the same, the Finance Bill proposes to insert a proviso to sub-section (1) of section 196A of the Act to the effect that the TDS would be at the rate which is lower of the rate of 20% and the rate or rates provided in agreement referred to in sub-section (1) of section 90 or sub-section (1) of section 90A of the Act, in case of a payee to whom such agreement applies and such payee has furnished the tax residency certificate referred to in sub-section (4) of section 90 or sub-section (4) of section 90A of the Act. Thus, the lower treaty rate will be applicable on production of a residency certificate and will not apply automatically.

Lastly, there is another provision relating to withholding at a lower rate from income of certain non-residents. Section 194LBA of the Act, provides that business trust (REITs etc.) shall deduct and deposit tax at the rate of 5% on interest income of non-resident unit holders. Representations were received to the effect that in some cases rate of deduction may be required to be reduced due to some exemption, for example exemption under section 10(23FE) of the Act allowed to notified Sovereign Wealth Funds and Pension Funds. However, since certificate for lower deduction under section 194LBA of the Act cannot be obtained under section 197 of the Act, benefit of exemption is not available at the time of tax deduction. Section 197 (1) has therefore been amended to provide that the sums on which tax is required to be deducted under section 194LBA of the Act shall also be eligible for certificate for deduction at lower rate.

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