BDO India: Countdown to the Budget 2021_Vol-2

As we draw closer to the India Union Budget 2021, BDO India is pleased to share Volume 2 of our Pre Budget campaign: Countdown to The Budget 2021, A two-volume series summarising key expectations from this year’s Budget announcements

With the advancement of information and communication technology, the procurement and supply of goods and services digitally, has witnessed exponential expansion across the world, including in India. Levying a tax on such digital business has been a significant challenge for several countries. India has been a frontrunner on levying tax on digital business by introducing Equalisation Levy; bringing the concept of ‘Significant Economic Presence’ & imposing a withholding tax on e-commerce transactions under the Income Tax Act, 1961 (‘IT Act’); and levying service tax / GST on Online Information and Database Access Or Retrieval services (‘OIDAR’). Alternately, from a non-resident’s perspective, the Indian government has taken several steps to encourage investment into India, provide tax transparency, etc. It is now, expected that Union Budget 2021 (‘Budget’) will carry measures directed towards tax on digital businesses and non-residents. Some of these measures could include:

1. Tax on Digital Business

• The Finance Act, 2020 expanded the scope of Equalisation Levy (‘EL’); it is now expected that the Budget will provide clarity on some of the terms used in the scope of EL and a list of exclusions that shall be outside the purview of EL.
• To limit the enlarged scope of the extent Significant Economic Presence (‘SEP’) provisions, it is expected that the Budget may provide that only specified services or activities, carried out by a non-resident through digital means, will constitute SEP in India.

2. Residency

• For Individuals - Due to COVID-19, many expatriates or foreign nationals were stranded in India thereby exposing them to be classified as tax resident. To grant relief to such individuals, the CBDT had issued a Circular for FY 2019-20 providing exclusion of certain number of days in India, on account of the lockdown restriction. On similar lines, it is expected that a provision may be brought into the statue for FY 2020-21.
• For Companies - Where an expatriate / foreign national (present in India) takes key decisions for foreign companies, such foreign companies could be exposed to Place of Effective Management (POEM) risk. Therefore, it is expected that the Budget may provide some relaxation in such cases where the key decision-makers had to stay in India due to the COVID-19 induced lockdown and travel restrictions.

3. Rationalising tax withholding in case of FPI / FII

• With the abolishment of Dividend Distribution Tax, the classic system of taxing dividends is in force wherein investors are taxed, and the Indian company is required to withhold tax. In the case of non-resident investors (other than FPI/FII), the Indian company is required to withhold tax at 20% or as per the applicable provisions of the DTAA, whichever is more beneficial. However, in the case of FPI / FII, the DTAA benefit is not available, in accordance with section 196D of the IT Act. Hence, similar to the case of other non-resident investors, it is expected that the Budget may permit DTAA benefit to FPI / FII as well.

4. Transfer Pricing (TP)

On the TP front, the pandemic may have had a disruptive effect on the margin of comparable companies impacting comparability analysis. It is expected that the Budget may consider the following:

• Mandatory 3 years weighted average of comparables’ margins may be replaced with a single year margin of comparables (i.e. for COVID-19 year).
• Extraordinary costs (including payroll cost, cost of idle staff, etc.) may be eliminated from the cost base in computing cost plus a margin for comparability purposes.
• Compensating adjustment to be permissible as unilateral adjustment may result in double taxation.
• Safe Harbour Rules (valid only till FY 2019-20) provides that transfer price declared by an eligible taxpayer in respect of a specified transaction (with overseas group entities) shall be accepted by the Revenue Authorities, subject to fulfilment of prescribed conditions. The Budget may further extend the Safe Harbour Rules by two more fiscal years and may revisit to rationalise the prescribed threshold by bringing them in line with the current economic state of affairs.
• Advance Pricing Arrangement (‘APA’) - Specific provisions may be introduced to clarify that disruption of critical assumptions for the impacted year (if at all) does  not require a renegotiation of the entire APA.

5. Merger

• While the Companies Act, 2013 and Reserve Bank of India have specific provisions on cross border mergers; it is expected that the Budget may provide guidelines on tax neutrality in case of a merger of an Indian company with an overseas company.

6. Attracting Overseas Funding

• India has recently permitted Indian companies to list on select overseas bourses. While the modalities are in the process of being framed, on an income-tax front, it is expected that the Budget may clarify that the current tax provisions relating to Indian listed companies (such as lower capital gains tax rate on the sale of such listed shares; exemption from applicability of section 79 – carry forward of losses in case of a change in shareholding; exemption from sale of such listed shares at FMV; etc.) will be extended to Indian companies listed on overseas stock exchanges.

7. Dispute Resolution / Tax Certainty

• Foreign investors are wary of the uncertainty in India and prolonged income-tax litigations. The existing mechanism to bring tax certainty and reduce tax litigation seem to be inadequate; therefore it is expected that the Budget may bring corrective measures towards tax certainty and reduce tax litigation, thereby ushering foreign investors’ confidence.

Separately, from an indirect tax perspective, it is expected that the government may primarily focus on measures to boost export and ease of doing business in India. On this front, the following amendments may be announced in the Budget:  

• ‘Place of supply’ for intermediary services provided to overseas entities may be changed to ‘location of the service recipient’ instead of ‘service provider’ and thereby removing GST on intermediary services provided by Indian entities to overseas entities.
• Extension of IGST exemption on import of goods by EOU may be allowed beyond 31 March 2021, to promote exports and foreign exchange earnings.
• Grant of refunds on GST paid or accumulated Input Tax Credit (ITC), without delay.
• Removal of IGST on ocean freight in the hands of an importer multiple times (once as part of Customs duty and again as a supply of service on Reverse Charge basis) to avoid dual taxation, especially when (ITC) is not available.
• Providing refund of inverted duty (where output tax is lower than input) structure without delay and considering the accumulation of input services while calculating refund on inverted taxed supplies.
• Encouraging export processing by framing simple and transparent guidelines with single-window clearances.

Conclusion

As we draw a close to India’s first phase of the COVID-19 vaccination drive, the economy is advancing towards recovery. Issuing necessary amendments in the Budget, will certainly boost foreign investors’ confidence in India and support the ‘Make in India’ and ‘Ease of Doing Business in India’ initiatives.

We will be analysing the budget proposals as they are announced on 01 February 2021.