<b>Vikas Vasal</b>: Towards a better tax policy

General Anti-Avoidance Rules come into effect on April 1

The Union Budget has adopted a pragmatic approach to boost consumption and investment, focusing on rural development, infrastructure and digitisation. On the tax policy front, a few clear themes have emerged: First, consistency in policy, evident from the absence of too many changes in the fine print; second, certainty and clarity on contentious issues, to avoid disputes and litigation; and third, widening of the tax net through multiple measures. Some provisions are likely to impact mergers and acquisitions, corporate re-structuring and investment planning in future.

Global companies have lots of leeway to structure their investments in different tax jurisdictions, especially in relation to equity and debt. Owing to different tax treatment in different tax jurisdictions on interest, dividends and other incomes, investment structures are drawn up 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 recommended measures in its final report to address this issue.

The Budget has proposed that tax deductibility of interest payment to foreign associated enterprises will 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 the maximum permissible limit. To exempt small interest payments, a threshold for 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 the case of multi-layered corporate structures, especially 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 structured their investments through private trusts for reasons such as safeguarding the interests of family members and ensuring proper succession planning, to avoid disputes. The Budget proposes to extend dividend tax in the hands of all categories of resident tax payers, except corporates and charitable institutions, thus covering trust structures within its ambit. This will increase the tax costs of several business groups where shares are held by family trusts. Accordingly, these provisions will require a rethink on succession planning through trust structures.

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 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. The Budget has introduced an anti-abuse provision to the effect that where the consideration for transfer of shares of a company, other than a quoted share, is less than the Fair Market Value (FMV) of such share, the FMV will be deemed to be the full value of the consideration for the purpose of computing capital gains tax. Further, receipt of any property (including unquoted shares) at less than FMV could also trigger taxation in the hands of the recipient as income from other sources. This may lead to taxation of the same amount, in the hands of both transferor and transferee. This provision requires reconsideration, and an exemption should be carved out for genuine group re-structuring, 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, will be available only if the acquisition of shares is chargeable to the 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 IPOs, FPOs, bonus or rights issues will be notified. The exemptions to be provided need to drafted carefully to cover cases such as ESOPs, as well as to ensure that no hardship is caused to genuine tax payers.

India has introduced General Anti-Avoidance Rules (GAAR) with effect from April 1, 2017. These are general regulations that 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 in 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.

Clearly, tax structuring will undergo a change once the Budget provisions come into effect, and all future investment planning and structuring will have to be subjected to the rigours of the above provisions. The writer is National Leader - Tax, Grant Thornton India. This article was written with assistance from Gaurav Mittal, a chartered accountant