Budget 2017: Why these five tax rules spook corporate India

Budget 2017 is likely to clarify the government’s position on Minimum Alternative Tax (MAT), General Anti Avoidance Rules (GAAR), Place of Effective Management (PoEM), Base Erosion and Profit Shifting (BEPS) and Income Computation & Disclosure Standards (ICDS), writes Sudipto Dey.

MAT impact on IND-AS conversion  

Background

From April 2016, companies with net worth of Rs 500 and above began re-stating their accounting numbers in IFRS-compliant Indian Accounting Standards (Ind-AS). This will be mandatorily extended to companies with net worth greater than Rs 250 crore from April 2017.  

Ind-AS is largely based on fair-value accounting. This involves accounting for various benefits or costs that are unrealised or notional, leading to taxation on a notional basis. “Based on the Ind-AS conversion guidelines, companies will need to undertake a one-time adjustment of various accounting treatments in opening retained earnings,” says Nabin Ballodia, partner, tax, KPMG in India. The transition to Ind-AS provides certain options to corporates that could increase or decrease the retained earnings based on the choices made. 

“In general, this will increase the retained earnings of corporates because Ind-AS relies on the fair valuation concept whereas corporates have traditionally followed the historical cost method,” notes RK Garg, director, finance, Petronet LNG.

Challenges

A note prepared in this regard by Deloitte India points out that in the Ind-AS scenario computation of income under MAT and normal tax provisions present various technical issues. One key question is: should the notional income or expenses recognised in Ind-AS be considered for the purposes of tax computation? Moreover, companies are grappling with the question of what should be the starting point for calculation of MAT profits, the note says.

The government constituted the MP Lohia Committee to look at the MAT aspects on conversion to Ind-AS. The committee has submitted three reports to the Central Board of Direct Taxes. One of the recommendations of the committee has been that one-time adjustments should be taxed in three equal instalments spread over three years. “For MAT-paying companies this could mean a huge outflow of tax for the first three years,” says Garg.

There has been no clarity on MAT calculations even when the principals are applicable in the current financial year.  “This may result in interest liabilities for no fault of the corporates,” says Ballodia.

Resolution expected in the Budget

One of the key expectations of corporates is that the payment of taxes due on account of the one-time adjustment should be spread over five years. 

Many also want the MAT credit to be carried forward without any time limit. Tax experts expect the government to offer a relief in interest payable on account of the shortfall in advance tax payment for companies that come under MAT.

The Budget may also provide a roadmap for phasing out MAT, which was brought in to tax companies that were making profits but did not pay taxes due to various tax holidays. As the tax holidays are being been phased out, so should MAT, feel tax experts.

Base Erosion & Profit Shifting (BEPS)

Background

The loopholes and concerns in existing international tax system leading to base erosion and profit shifting were identified and taken up as a project by the OECD and G-20 nations. The challenges posed included taxing the digital economy and the disparity in allocation of profits among countries based on value-chain analysis.

In India as part of the BEPS project, the equalisation levy was introduced as a self-contained code to tax e-commerce transactions under Chapter VIII of the Finance Act, 2016.  “We expect that detailed country-by-country reporting, master file and local file rules on the lines of OECD Action Plan 13 should be released before or as part of Budget 2017,” says Kanabar of EY. 

Challenges

Taxpayers face challenges in determining whether various e-commerce transactions attract the equalisation levy, though not primarily undertaken for the purpose of advertisement. These include transactions involving website hosting services, service fee for sale or display of goods on digital platforms, and certain specific marketing services.

Further, the signing of the multilateral instrument in the first half of 2017 could have a far-reaching impact on the international tax framework.

Resolution expected in the Budget

To avoid disputes on classification of services liable to the equalisation levy, the government should clarify the scope and coverage of payments, says Saiya of BDO India.

General Anti Avoidance Rules (GAAR)

Background

The provisions of GAAR will be applicable from April 1. However, guidelines for their effective implementation are still awaited. GAAR examines cases of aggressive tax planning involving inbound and outbound transactions, acting as a deterrent to treaty shopping. 

The provisions of GAAR will be applicable to any tax benefit obtained from an arrangement on or after April 1. GAAR will override tax treaty provisions and tax officials are allowed to deny tax benefits if a deal is found without any commercial purpose other than tax avoidance.  

Challenges

Tax experts point out given the limited timeframe for taxpayers and tax authorities to understand the pending guidelines, it will be practical to defer the effective date for implementation by a reasonable period.   

“The guidelines should clarify that GAAR is a deterrent provision, and not a tax collection provision. It should be invoked only in cases of patently abusive, contrived and artificial arrangements,” says Samir Kanabar, partner, tax, EY India.  Another issue faced by tax experts is that there are no specific penalty provisions in case GAAR provisions are invoked. Accordingly, tax authorities are likely to take recourse to two broad categories under normal penalty provisions-- “under-reporting’’ (entailing 50 per cent penalty) and “mis-reporting” (entailing 200 per cent penalty). “It is critical to have guidelines laying down objective criteria for distinguishing cases of gross abuse from other cases, as well as clarifying the situations or circumstances and providing parameters for initiating and levy of penalty,” says Kanabar. Rakesh Nangia, managing partner, Nangia & Co, points out that it is important to implement the provisions of GAAR in a way that they do not lead more litigation.

Resolution expected in the Budget

Tax experts expect the government to defer the provisions of GAAR by a couple of years. A note by Deloitte India points out that in the case of residents there are ample anti-avoidance provisions.

Some expect the ambit of GAAR to be examined afresh in light of recent amendments in various tax treaties that incorporate various anti-abuse provisions.

PoEM (Place of Effective Management)

Background

In an attempt to counter tax evasion through creation of shell companies, Budget 2015 introduced a new test for corporate residency. It provides that a foreign company may be treated a resident of India for tax purposes if its place of effective management in that year is in India. 

Challenges

Though the provision became effective last April, the rules outlining guiding principles for determination of PoEM are not yet notified. 

“The draft guidelines issued earlier for public comments involved subjective criteria and were prone to different interpretations. Further the transitional provisions for implementation of PoEM are not yet announced as provided in the new Chapter XII-BC introduced by Finance Act, 2016,” says Jiger Saiya, partner, direct tax, BDO India. Nangia points out that PoEM may lead to unwarranted litigation since at times characteristics of effective management exist in a number of jurisdictions without a single jurisdiction being dominant.

Resolution expected in the Budget

Most tax experts feel that pending final guidelines and transitional provisions, applicability of PoEM-related provisions should be deferred. 

Once announced, the government must provide sufficient time to taxpayers to understand and correct business models, say experts.

To tackle similar issues several developed countries have introduced a more formulated regime of controlled foreign corporations, popularly known as CFC Regulations.  “As against global income, CFC will tax only the passive income of certain foreign entities located in low-tax jurisdiction and being controlled from India,” says Saiya.

Income Computation & Disclosure Standard (ICDS)

Background

Currently, most corporate entities determine taxable income using Indian accounting standards. However, the CBDT proposed the adoption of ICDS under the Income Tax Act in March 2015. These standards prescribe principles for recognition and measurement of different items of income, expenditure, assets and liabilities to compute taxable income. These standards are to be applied effective from last April by specified taxpayers following the mercantile system of accounting for the purpose of computation of business or professional income or income from other sources.

Challenges

ICDS are prescribed to compute taxable income and not for maintaining books of accounts. Taxpayers have expressed concern that this will lead to maintenance of additional records and will add to the time and cost of compliance for smaller corporates.

Tax experts point out that the notified ICDS state that in case of conflict between ICDS and provisions of the Income Tax Act, the Act shall prevail. However various court rulings have interpreted provisions of the Act in the absence of clear language/mandate in legal provisions, says Saiya of BDO India. Another challenge for taxpayers is whether ICDS provisions will nullify or dilute the judicial decisions in various Supreme Court and High Court rulings.

Resolution expected in the Budget

Tax experts are unanimously in favour of withdrawing ICDS.

The Easwar Committee is reported to have also proposed that implementation of ICDS be deferred or withdrawn. 

A note by Deloitte India on the issue says the computation of taxable income should be in accordance with accounting standards notified by the ICAI.

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