The tax regime for foreign institutional investors (FIIs) is separately outlined under the current law in Section 115AD. In any case, in several situations, treaty provisions would apply.
The direct tax code (DTC) seeks to provide a 30% tax rate on capital gains earned by FIIs; there is lack of clarity regarding treaty applicability. Obviously, this is a serious and fundamental issue and presumably, would be separately addressed in light of many representations being made.
In any case, assuming that some tax applies to FIIs, the issue relating to TDS (tax deduction at source) thereon is discussed below.
Under the current law (Section 196D), payment of sale proceeds on shares and other securities of FIIs is exempt from TDS.
This is keeping in mind the practical difficulty in deducting tax on such payments in terms of determining the capital gains (income) amount, practical impracticability since shares are sold on stock exchange where the seller may not be known, etc. Through a separate arrangement, though, the taxes due are duly recovered at the time of remittance of the sale proceeds outside India through the custodian banker.
The DTC does not provide for the above exemption. This may lead to chaos when applied at the ground level on a day-to-day basis as highlighted above for share sale by domestic investors on issues such as, who should deduct— buyer or stock exchange or the broker, how much—on entire sale proceeds or capital gains, in case of the latter, how do you compute, etc. Clearly, this does not seem feasible and could seriously impact FII investments, if implemented.
Are the rates realistic? Cash trap? While the TDS rates are applied typically with reference to the gross payment, it is important to note that the intent and purpose of the TDS provisions is to collect taxes that would be eventually due from the taxpayer. Thus, there needs to be a correlation between the applicable TDS rate and the estimated tax liability of the recipient taxpayer. For instance, a 10% TDS rate as applicable to other income payments, presupposes a 40% PBT (profit before tax) margin (@ 25% corporate tax rate). Is this for real? Else, it could mean a substantial cash trap for companies in the form of withholding taxes suffered.
The DTC (as under the current law) also provides for presumptive basis of taxation for various categories of resident and non-resident businesses. Take the case of a foreign airline or shipping company. While the DTC provides for computing tax liability (@ 25%) based on a presumptive income base of 5-7.5% of the India receipts (thus an effective tax liability of 1.25-1.87% of the gross receipts), the payments to such airline/shipping companies could suffer withholding of as high as 35% of gross receipts.
Clearly, an unnecessary cash trap. In fact, a 35% withholding on gross basis for these companies, which are already into huge losses and highly leveraged, could mean a relook at the fundamentals of doing business in India.
Illustration: Jayachandran / Mint
One hopes that such incongruence in tax collection vis-à-vis the final tax liability is appropriately addressed in the final Code.
Deductor at ransom? Undoubtedly, the deductors, mostly corporates, shoulder a huge burden in collecting the taxes on behalf of the government. The DTC provides that in case any alleged non-withholding is not made good by the deductor within a period of two years, the deduction would lose the right to claim the subject payment as a deduction in computing his tax liability. This seems harsh, especially where a deductor does not withhold under a bonafide belief that the subject payment is not covered by the TDS provisions, but the tax department thinks otherwise. In such a situation, say, pursuant to appeal proceedings which would invariably take at least two years in the present circumstances, even if the deductor makes good the alleged non-withholding, he would have lost the right to claim the deduction.
Another instance is of applying a higher 20% TDS rate where the recipient does not furnish PAN (permanent account number). This again calls upon additional administrative efforts for the deductor. Especially in “net of tax” payments, practically, the deductor ends up bearing the additional tax liability since, either the recipient may not provide a PAN or has not applied/required to apply for a PAN (especially in non-resident cases). Clearly, this seems harsh on persons doing a service to the nation. The only point to make is to correlate the “quantum of the punishment” with the “measure of the crime”, especially in such onerous circumstances.
The code’s attempt to simplify tax laws is important and welcome. However, it is equally important that the provisions are tested and are compatible with the prevailing business practices; else it could result in serious and often unintended consequences.
One hopes that some of the practical consequences discussed above are appropriately addressed while finalizing the code.
The first part of this column on the direct tax code appeared on 21 September.
Ketan Dalal is executive director and Vishal Shah is associate director, PricewaterhouseCoopers.
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