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India’s finance minister Nirmala Sitharaman presented the Union Budget 2021 on 1 February. As far as direct taxes are concerned, the focal areas were administrative reforms, status quo in tax rates, ease in compliance, reduction in litigation and providing impetus to foreign investors. We explain some of the key direct tax proposals.

Status quo in tax rates

Despite the huge fiscal deficit, there is no change proposed in the tax rates applicable to individuals, firms, LLPs and companies. The government has instead relied on non-tax measures to garner funds and pinned its hope on buoyancy in direct and indirect tax collections, in view of the uptick in economy. This is a big respite for taxpayers who were anticipating introduction of additional covid cess or increase in tax rates for high income earners, to fund the additional resources required for coronavirus relief measures, including the vaccination drive.

Maintaining status quo on tax rates also sends a strong signal to the investors that the government is committed to a long-term stable and predictable tax policy, despite the current fiscal constraints.

Scope widened for equalization levy (EL 2.0)

Last year, the Budget 2020 had expanded the scope of digital tax to include e-commerce operators in the form of EL 2.0. While Budget 2021 has addressed some concerns of stakeholders on this levy, it has further expanded its scope.

It was earlier provided that any taxpayer subjected to EL 2.0 shall be exempted from income tax. However, while the EL 2.0 provisions were applicable from 1 April 2020, this exemption was made effective from 1 April 2021, consequently leading to possible double taxation. It is now proposed to make the exemption provision effective from 1 April 2020, thereby addressing this anomaly.

Definition of ‘online sale of goods’ and ‘online provision of services’ is proposed to be clarified in the budget to include online acceptance of offer of sale or placing/acceptance of purchase order or online payments. This has vastly expanded the scope of this levy and has raised various issues, as a large number of cross-border transactions could be impacted and would need to be evaluated vis-à-vis this levy.

It has also been clarified that if the consideration for online sale of goods or provision of services are taxable as royalty or fees for technical services, then it would be excluded from the ambit of EL 2.0. Further, it has been clarified that gross consideration received by the e-commerce operator would be subjected to EL 2.0 irrespective of whether he sells his own goods or services, or is merely acting as a facilitator. These clarifications are retrospectively applicable from 1 April 2020.

Defining the term ‘liable to tax’

The term “liable to tax" often used in tax treaties was not defined in the domestic tax laws and has been a subject of disputes and litigation. It is now proposed to be defined to mean that there is a liability of tax on a person under any law, in any country. It would also include cases, where a specific exemption has been granted to a person.

Relief for returning Indians–Overseas retirement funds

There existed a mismatch in the year of taxability of receipts from an overseas retirement fund by residents in India, who had contributed to such funds while they were employed overseas or when they were the residents of a foreign country.

At present, the withdrawal from such funds may be taxable on receipt basis in the foreign country and on accrual basis in India. The budget has proposed to address this hardship and accordingly a suitable methodology to tax the same would be rolled out.

Relief to foreign institutional investors

As a relief to foreign institutional investors (FIIs), benefit of lower tax rate under the applicable treaty can now be availed at tax withholding stage itself, provided a valid tax residency certificate is available.

Tax incentive to sovereign wealth funds (SWF) and pension funds (PFs)

To encourage foreign investments, in the previous budget, the government had introduced certain provisions to exempt income of SWFs/PFs arising from an investment made in the infrastructure sector in India. SWFs and PFs were allowed to invest in category I or II Alternative Investment Funds (AIFs), which in turn held 100% investment in infrastructure sector companies. It is now proposed to relax the investment threshold to 50%.

It is also proposed to allow SWFs/PFs to make investment in a domestic company set-up and registered after 1 April 2021, provided such company has a minimum 75% of investments in infrastructure sector. The investments are also now being permitted in specified non-banking financial companies (NBFCs).

Providing boost to International Financial Services Center–Gift City

It is proposed that the investment division of a foreign bank located in IFSC will be exempt in respect of income from specified securities, subject to certain conditions. Further, tax exemption would be available to a non-resident on transfer of non-deliverable forward contracts entered into with an offshore banking unit of an IFSC.

Relocation of offshore funds to the IFSC before 31 March 2023 is proposed to be tax-neutral. Also, location of a fund manager of an eligible investment fund in an IFSC, would not constitute taxable presence in India for the fund, subject to certain conditions.

To promote aircraft leasing activity, certain tax benefits are proposed on fulfilling specified conditions. Accordingly, royalty income received by a non-resident on account of lease of aircraft, paid by a unit in IFSC would be exempt from income tax. Further, benefit of tax holiday is proposed for income earned by a unit in IFSC, from transfer of aircraft or aircraft engines.

Minimum alternate tax (MAT)

Presently, foreign companies are exempt under the MAT provisions on their income from capital gains, interest, royalty or fees for technical services, if the applicable rate of tax is less than the rate prescribed under MAT provisions. It is now proposed to also exempt the dividend income from the MAT provisions.

The MAT provisions are also proposed to be relaxed for any income being taxed in the previous years on account of secondary adjustments or advance pricing arrangement under the transfer pricing provisions.

Business reorganizations

In a move that will impact business re-organizations, it has been clarified that depreciation will not be available on goodwill, irrespective of the fact that it is acquired pursuant to a restructuring or specifically purchased. Depreciation claimed, if any, on such goodwill before 1 April 2020, will need to be adjusted from the cost of acquisition. It is also clarified that there would be capital gain implications in slump exchanges. Going forward, the merger and acquisition transactions will have to take note of this important change in the tax provisions for goodwill.

Dispute resolution

Recently, the government had introduced faceless assessment, faceless appeal and faceless penalty schemes to bring greater transparency and accountability in tax system. This scheme is now proposed to be extended to Income Tax Appellate Tribunal (ITAT) i.e. the second appellate authority.

It is also proposed to replace the present Authority for Advance Rulings (AAR) with Board for Advance Rulings (Board). The Board would be manned by senior personnel from the tax department. The order of the Board will be appealable before the High Court.

The government has also proposed a new alternative dispute resolution scheme for small and medium taxpayers. The intent of the scheme is to settle the disputes at initial stage itself. The taxpayers whose returned income is less than 5 million and the aggregate variation proposed is 1 million or less can opt for the scheme.

Return filing

To expedite the return filing and assessment process, time limit for filing belated or revised return is proposed to be reduced by three months. Such returns can now be filed within nine months from the end of the relevant assessment year (AY) or completion of the assessment, whichever is earlier. Similarly, time limit for issuing revenue audit notice by the department is proposed to be reduced from six months to three months, from the end of relevant AY.

Re-assessment provisions

To reduce litigation, a new procedure and time limit for reopening of cases has been proposed. The prevailing time limit for reopening ranges from 4 to 16 years. The proposed time limit is as follows:

—3 years (where income escaping assessment is not likely to exceed `5 million); and

—10 years (where income escaping assessment is likely to exceed `5 million)

Overall, the budget contains several proposals which will contribute to positioning India as an investment and tax-friendly destination. Various administrative reforms and the government’s continued efforts to reduce litigation are seen as yet another step to further ease of doing business in India.

Richa Sawhney and Sameer Shah contributed to this article.

Vikas Vasal is national leader-Tax at Grant Thornton Bharat LLP.

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