Direct tax Code changes impacting taxation of Foreign Institutional Investors

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1 KPMG IN INDIA Direct tax Code changes impacting taxation of Foreign Institutional Investors Background As a result of numerous amendments to the Income-tax Act, 1961 ( the Act ) from time to time, the basic structure of the Act is burdened and its language complex. The Government, therefore, decided to revise, consolidate and simplify the language and the structure of the direct tax laws. A draft Direct Tax Code 2009 ( DTC 2009 ) along with a Discussion Paper was released in August 2009 for public comments. Based on the feedback received from the various stakeholders, DTC 2009 was revised in June The present Bill, the Direct Tax Code 2010 ( DTC 2010 ) was tabled in the Parliament on 30 August DTC 2010 is proposed to come into force on 1 April KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved.

2 The key changes as proposed by DTC 2010 that affect the taxation of Foreign Institutional Investors ( FIIs ) are as follows: At the outset, the DTC 2010 has put to rest the controversy surrounding the benefits available under the Double Taxation Avoidance Agreements (DTAA). It provides that between the Act and the relevant DTAA, the one which is more beneficial to the taxpayer shall apply. However, there would be limited treaty override in accordance with internationally accepted principles. Thus, DTAA will not have preferential status over the domestic law when GAAR is invoked; or, when CFC provisions are invoked; or, when Branch Profits Tax is levied. Distinction between long-term capital gains and shortterm capital gains eliminated Under the DTC 2010, income from all sources has been proposed to be classified into two broad groups: income from ordinary sources and income from special sources. Income from ordinary sources includes: Income from Employment; Income from House-Property; Income from Business; Income from Capital Gains; and Income from Residuary Sources. 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved.

3 Income from special sources in the case of a non-resident shall include income by way of: Interest; Dividends on which dividend distribution tax has not been paid; Profit distributed by a fund on which tax on distributed income has not been paid; Income by way of royalty or fees for technical services; and Income by way of insurance including reinsurance. Income of FIIs from transfer of investment assets is capital gain The term asset has been defined to mean a business asset or an investment asset. Any security held by a FII is an investment asset. Income arising on transfer of investment asset shall be computed under the head Capital Gains and shall be considered as income from ordinary sources in case of all taxpayers including non-residents. The term securities includes derivative as defined in section 2(h) of the Securities Contract Regulation Act, No Specific Code for FIIs Section 115AD of the Act specifies the tax rates in respect of the income streams of FII investments in India. The DTC 2010, however, has no specific provision which deals with the tax treatment of income of FIIs. The tax rates have been provided in the Schedules to the DTC KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 2

4 General Tax Rates Taxpayer Company Unincorporated body1 Tax Rate 30 percent 30 percent The general tax rate in the case of income of the FII is 30 percent in case of a company or an unincorporated body. This rate is applicable to all companies including corporate FIIs. Tax Rate on Interest Interest income will be taxed at the rate of 20 percent. Taxability of listed equity shares and units of equity oriented Mutual Funds subject to Securities Transaction Tax ( STT ) In case of an equity shares in a company or a unit of an equity oriented Fund, transferred at any time after one year from the date the asset is acquired and such transaction is chargeable to securities transaction tax, a deduction amounting to 100 percent of the income is to be allowed and if the income is negative, 100 percent of the income is to be reduced from such income. 1 Unincorporated body means a firm, an association of persons, or a body of individuals. 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 3

5 The changes are tabulated below: Description Current Proposed Current Proposed (held for more than 12 months from the date of acquisition) (held for a period of more than one year from the date of acquisition)** (held for less than 12 months from the date of acquisition) (held for a period of less than one year from the date of acquisition) ** (Amount in INR) (Amount in INR) (Amount in INR) (Amount in INR) Date of Acquisition 1st April st April st April st April 2011 Long-Term Asset if sold on or after 1 April 2012 Asset sold on or after 1 April 2012 Short-Term Asset if sold before 1 April 2012 Asset sold on or before 1 April 2012 Sale Value Less: Cost of acquisition and Cost of Improvement Capital Gains Less: Deduction at specified rates on capital Gains* Not Applicable 50 (specified rate is 100 percent of capital gains) Not Applicable 25 (specified rate is 50 percent of capital gains) Taxable Capital Gains Fully Exempt Nil Tax on Capital Gains Nil Nil 7.5 ( 15 percent) plus applicable surcharge and education cess 7.5 ( 30 percent plus additional income-tax) Tax on Capital Gains Nil Nil 7.5 ( 15 percent) plus applicable surcharge and education cess 7.5 ( 30 percent plus additional income-tax) * In case there is a capital loss, the same is also to be reduced by the specified percentage. ** The statement of objects and reasons to DTC 2010 provides that in respect of equity share and equity-oriented mutual fund unit, such securities should be transferred after one year from the end of the financial year in which it is acquired. This is an apparent anomaly with the DTC KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 4

6 It may be noted from the above table that in effect the long-term capital gains on sale of listed shares continue to be tax exempt and short-term capital gains on the sale of such shares will be taxed at half the applicable rates. Aggregation of Income The income (after providing for the deductions) from transfer of an investment asset during the financial year shall be aggregated and the net result shall be income from capital gains. The income from capital gains shall be aggregated with the unabsorbed preceding year capital loss, and the net result shall be current income under capital gains. The income under the head capital gains shall be NIL if the net result of aggregation is negative and the absolute value of the net result shall be the amount of unabsorbed current capital loss for the financial year Various scenarios are provided as under: Particulars ROI filed by the due date ROI not filed by due date Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Scenario 6 income of the current year - equity shares held less than one year A 5,000 5,000 (5,000) 0 (5,000) 5, percent B (2,500) (2,500) 2, ,500 (2,500) current income under the head capital gains C=A-B 2,500 2,500 (2,500) 0 (2,500) 2,500 unabsorbed capital loss - preceding year # D - (10,000) (10,000) (10,000) (10,000) (10,000) unabsorbed capital loss - current year to be c/f E=C+ D NIL (7,500) (12,500) (10,000) (10,000) (7,500) income under the head capital gains F 2,500 NIL NIL NIL NIL NIL #Theearlieryearreturnsofincomehavebeenfiledbytheduedate 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 5

7 Observations: a) If the return is filed by the due date, the unabsorbed capital loss of current year is allowed to be carried forward. This includes portion of the unabsorbed capital loss of the preceding year b) The loss is allowed to be indefinitely carried forward for set-off c) Loss under any head within ordinary sources can be set-off against income under the head capital gains. d) In case of delayed filing of the returns of income for any particular year, losses pertaining to that year would not be allowed to be carried forward for set-off in future years. Taxability of securities other than listed equity shares and units of equity oriented Mutual Funds For the purpose of computation of income from transfer of investment assets other than listed equity shares and units of equity oriented Mutual Funds, deduction of indexed cost of acquisition, indexed cost of improvement, will be allowed if such asset is transferred after one year from the end of the financial year in which the asset is acquired. If the asset is acquired before 1 April 2000, then the fair market value of such an asset as on 1 April 2000 shall be substituted at the option of the taxpayer. Withholding tax on Capital Gains and Interest income No tax is to be deducted at source from payments made to a FII, on any consideration for sale of securities listed on a recognized stock exchange. 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 6

8 Although payments made to FIIs for sale of shares listed on a stock exchange are free from any tax withholding, payment of interest income and unit income (other than by a equity oriented mutual fund) is subject to tax withholding of 20 percent. Further, a FII which invests through the Foreign Direct Investment ( FDI ) route and participates in an open offer faces a tax withholding of 30 percent on the sale consideration. Interest income of the non-resident is considered as income from special source and tax at the rate of 20 percent is to be deducted at source on the interest paid to non-resident. Broken Period Interest The DTC 2010 provides that the income accruing from a debt instrument, transferred by a person at any time during a financial year, shall not be less than the amount of broken-period income from the instrument. The term broken-period income shall be calculated as if the income from such securities had accrued from day to day and been apportioned accordingly for the broken period. Income not includible for purposes of arriving at taxable income of the taxpayer Dividend declared, distributed or paid to a company or a non-resident, in respect of which dividend distribution tax ( DDT ) has been paid by the Indian company at the rate of 15 percent Any income received from an equity oriented fund in respect of which tax on distribution has been paid by the Fund at the rate of 5 percent. Computation of income from special sources While computing income from special sources, any amount by way of accrual or receipt shall be taken and no deduction or allowance or set-off of 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 7

9 any loss shall be allowed. Such income shall be presumed to have been computed after giving full effect to every loss, allowance or deduction. Delayed filing of return of income In case of delayed filing of return of income for any particular year, losses pertaining to that year would not be allowed to be carried forward for set off in future years. Test of Residence Companies Currently, a foreign company is treated as resident in India if, at any time in the financial year, the control and management of its affairs is situated wholly in India In line with the international practice, it is now proposed that a company incorporated outside India will be treated as resident in India if its place of effective management is situated in India. The term place of effective management of the company means: (i) the place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or (ii) in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions. Other Person Every other person shall be resident in India in any financial year, if the place of control and management of its affairs, at any time in the year, is situated wholly, or partly, in India. 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 8

10 General Anti Avoidance Rule ( GAAR ) The DTC 2010 seeks to provide that any arrangement entered into by a person may be declared as an impermissible avoidance arrangement and the consequences, under this Code, of such arrangement may be determined by- a) disregarding, combining or re-characterising any step in the arrangement; b) treating the arrangement as if it had not been entered into or carried out or in such other manner as in the circumstances of the case, the Commissioner deems appropriate for the prevention or reduction of the relevant tax benefit; c) disregarding any accommodating party or treating any accommodating party and any other party as one and the same person; d) deeming persons who are connected persons in relation to each other to be one and the same person; e) re-allocating, amongst the parties to the arrangement, any accrual, or receipt, of a capital or revenue nature, or any expenditure, deduction, relief or rebate; or f) re-characterising any equity into debt or vice versa, any accrual, or receipt, of a capital or revenue nature, or any expenditure, deduction, relief or rebate. It is further provided that the above provisions may be applied in the alternative for, or in addition to, any other basis for determination of tax liability and they shall apply with such guidelines as may be prescribed. Presumptions: An arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, unless the person obtaining the tax benefit proves that obtaining the tax benefit was not the purpose of the arrangement 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 9

11 An arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit. Benefits under the Double Taxation Avoidance Agreements The DTC 2010 seeks to provide that the Central Government may enter into an agreement with the Government of any country or specified territory for the granting of relief or avoidance of double taxation ( DTAA ), for exchange of information for the prevention of evasion or avoidance of income-tax or wealth-tax, for tax recovery, etc. It is further provided that where such an agreement has been entered into, then the provisions of this Code will apply to the taxpayer to whom the DTAA is applicable, if such provisions are more beneficial to him except for provisions regarding General Anti Avoidance Rule, levy of Branch Profit Tax and Control Foreign Company Rules which will apply, whether or not such provisions are beneficial to him. A person shall not be entitled to claim relief under the provisions of the DTAA unless a certificate of his being a resident in the other country or specified territory is obtained by him from the tax authority of that country or specified territory, in such form as may be prescribed. 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 10

12 in.kpmg.com KPMG in India KPMG in India Bangalore KPMG Maruthi Infotech Centre 11-12/1, Mumbai Inner Ring Road Koramangala, Bangalore Phone: LodhaExcellus Fax: ApolloMillsCompound NMJoshiMarg,Mahalaxmi Chennai Mumbai KPMG Tel: No.10, Fax: Mahatma Gandhi Road Nungambakkam High Road Chennai Phone: Bangalore Fax: MaruthiInfo-TechCentre Delhi 11-12/1,InnerRingRoad KPMG Koramangala,Bangalore B, Tel: DLF Corporate Park DLF Fax: City, Phase III Gurgaon, Haryana Phone: / Fax: Hyderabad Hyderabad /2 KPMG RelianceHumsafar,4thFloor /2 RoadNo.11,BanjaraHills Reliance Hyderabad Humsafar, 4 th Floor Road Tel: No.11, Banjara Hills Hyderabad Fax: Phone: Fax: Kochi Kochi KPMG 4/F,PalalTowersM.G.Road 4/F, Ravipuram, Palal Towers M. Kochi G. Road, Ravipuram, Kochi Tel: Phone: Fax: Fax: Chandigarh SCO stFloor,Sector8C MadhyaMarg Kolkata KPMG Infinity Benchmark, Plot No. G-1 10th New Floor, Delhi Block EP & GP, Sector V Salt Lake City, Kolkata Phone: BuildingNo.10,TowerB / 64/62 Fax: 8thFloor,DLFCyberCity, Phase II Mumbai Gurgaon122002Haryana KPMG Tel: Kamala Fax: Mills Compound 448 Senapati Bapat Marg Lower Parel, Mumbai Phone: Chennai Fax: No.10MahatmaGandhiRoad Pune Nungambakam, KPMG Chennai , Tel: th Floor Godrej Castlemaine Next to Ruby Hall Clinic Bund Garden Road, Pune Phone: /65 Fax: Chandigarh Fax: SCO22-23 IstFloor,Sector8C Kolkata MadhyaMarg Chandigarh InfinityBenchmark Tel PlotNo.G-1,10thfloor, Block-EP&GP,Sector-V,SaltLakeCity Kolkata Tel: Fax: Pune 703,GodrejCastlemaine BundGarden Pune Tel: /65 Fax: Theinformationcontainedhereinisofageneralnatureandisnotintendedtoaddressthecircumstancesofanyparticularindividualorentity. Althoughweendeavortoprovideaccurateandtimelyinformation,therecanbenoguaranteethatsuchinformationisaccurateasofthedateitis receivedorthatitwillcontinuetobeaccurateinthefuture.nooneshouldactonsuchinformationwithoutappropriateprofessionaladviceaftera thoroughexaminationoftheparticularsituation KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependentmemberfirmsaffiliatedwithKPMGInternational 2010KPMG,anIndianPartnershipandamemberfirmoftheKPMGnetworkofindependent Cooperative( KPMGInternational ),aswissentity.allrightsreserved. memberfirmsaffiliatedwithkpmginternationalcooperative( KPMGInternational ),aswissentity. Allrightsreserved 11

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