Tax structuring: Caution and care, post Budget

A pragmatic approach has been adopted in this year’s Union Budget to boost consumption and investment, with focus on rural development, infrastructure and digitisation. On the tax policy front, there are a few clear themes emerging from the Budget. First, consistency in policy, as is evident from not too many changes in the fine print. Second, providing certainty and clarity on contentious issues to avoid disputes and litigation. Third, to widen the tax net through multiple measures. There are a few provisions in this year’s Budget that are likely to impact mergers and acquisitions, corporate restructuring and investment planning in future.  

Global companies have a lot of leeway to structure their investments in different tax jurisdictions, especially in relation to equity and debt. Due to different tax treatment in different tax jurisdictions on interest, dividends and other incomes, investment structures are drawn to optimise tax benefits. The Organisation for Economic Cooperation and Development (OECD) in its Base Erosion and Profit Shifting project in Action Plan 4 has taken up the issue of profit-shifting by large companies by way of excess interest deductions. OECD has accordingly recommended various measures in its final report to address this issue.

This year’s Budget has proposed that tax deductibility of interest payment to foreign associated enterprises shall be restricted to 30 per cent of earnings before interest, taxes, depreciation and amortisation (EBITDA). The disallowed interest expense will be carried forward to eight years and set off against the income computed under the head “profits and gains of business or profession”, provided that in the succeeding assessment year as well deduction shall be allowed to the extent of maximum permissible limit, as aforesaid. In order to exempt small interest payments, a threshold of interest expenditure of Rs 1 crore has been provided.  Further, banking and insurance businesses have been kept outside the ambit of these provisions. 

Dividends have been an important source of income in case of multi-layered corporate structures, especially the promoter holding structures.  Last year, an additional tax on dividend income was introduced on individuals or HUFs receiving dividends of more than Rs 10 lakh in a year. Many business promoters and high net worth individuals have planned and structured their investments through private trusts for various reasons, including to safeguard the interests of their family members, ensure proper succession planning to avoid disputes among family members etc. In this year’s Budget, it has been proposed to extend dividend tax in the hands of all categories of resident taxpayers except for companies and charitable institutions, thus, covering the trust structures within its ambit. This would increase the tax costs of several business groups where shares are held by family trusts.  Accordingly, these provisions would require a rethink on succession planning through trust structures.

Illustration: Binay Sinha

In case of group restructuring, a simpliciter transfer of assets or shareholding from one company to another attracts taxation, even though it may be a case of realignment or restructuring of business or asset holdings and does not result in cash profits at the group level. Thus, it has been a common practice to transfer assets at cost or nil value to ensure that intra-group transfers do not result in tax outflow.  This Budget has introduced an anti-abuse provision to provide that — where consideration for transfer of share of a company, other than a quoted share, is less than the fair market value (FMV) of such share, the FMV shall be deemed to be full value of consideration for the purposes of computing capital gains tax. Further, receipt of any property (including unquoted shares) at less than FMV could trigger taxation in the hands of the recipient as income from other sources. This may lead to taxation of the same amount, both in the hands of transferor and transferee. This provision requires a reconsideration, and an exemption should be carved out for genuine group reorganisation/restructuring, done for business reasons.

To prevent abuse of the tax benefit in case of long-term capital gains on listed securities, it is now proposed that exemption from capital gains on transfer of equity shares acquired on or after October 1, 2004, shall be available only if the acquisition of shares is chargeable to securities transaction tax (STT). It has also been clarified that exemption for genuine cases where STT could not have been paid on acquisition of shares in case of initial public offering, follow on public offer, bonus or rights issue etc. will be notified. The exemptions to be provided need to drafted carefully to cover cases like ESOPs etc, as well as to ensure that no hardship is caused to genuine taxpayers.

India has introduced General Anti-Avoidance Rules (GAAR) with effect from April 1, 2017. These are general regulations and do not focus on any specific tax avoidance practice(s). Given this aspect, each tax planning structure has to be tested on the threshold of GAAR to make sure that it does not cross over into the domain of tax avoidance. It is good to note that some guidance has been issued recently on GAAR.  However, some areas still require more clarity. In any event, all future investment structures and transactions will have to withstand the test of GAAR, thereby requiring abundant care and caution.

It is quite clear that the world of tax structuring will undergo a change once this year’s Budget provisions come into effect and all future investment planning and structuring will have to go through the rigours of the above provisions.
The writer is national leader, tax, Grant Thornton, in India. With inputs from Gaurav Mittal

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