India Budget 2016: Business Elements

By Dezan Shira & Associates
Editor: Tracie Frost

When Finance Minister Arun Jaitley released the 2016 Union Budget on February 29, the response was mostly positive.  The budget aims to stick to the 3.5 percent fiscal deficit target, addresses pressing social and infrastructural needs, and, for the most part, uses reasonable assumptions to forecast India’s growth over the next three years.

The Modi government has consistently focused on increased ease of business, opening markets to foreign investment, building India’s industrial sector, and improving transparency in taxation and regulation. While this budget delivered more on rural and infrastructure spending, it certainly includes some business elements that are worth exploring in detail.

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Taxation:

Taxation of dividend income

The bill would introduce a new dividend tax for recipients of dividends in excess of US $15,000 (Rs 1,000,000). The tax rate would be 10 percent on a gross basis. This is in addition to the approximately 20 percent dividend distribution tax that the distributing company already pays on the dividend distribution. Previously, recipients of dividends from Indian companies were exempt from tax. The new law makes recipients in excess of one million rupees liable for tax on Indian and foreign distributions.  This will reduce the benefit of investing in Indian companies that issue dividends. Further, since the budget announcement several companies have already announced dividends to be paid before the April 1, 2016 effective date of the law.

Equalization Levy

The budget establishes an “equalization levy” of six percent on payments made to non-resident Indians for online advertising, except where the non-resident has a permanent establishment in India and the services are effectively connected with the permanent establishment.  The law will apply to Indian corporations which pay more than US $1,500 (Rs 100,000) per year for specified digital services to non-resident entities. This law aims to withhold tax from digital e-commerce companies with no place of business in India who receive large amounts of advertising revenue from Indian firms. Previously, online companies such as Google and Facebook paid no tax in India despite their tremendous online presence because they had no permanent establishment in India. The tax will act like a withholding tax which Indian concerns will deduct on payments for specified digital services, principally advertising. While the bill applies to online advertisements, some practitioners worry that the government could widen the scope to cover other services and even business-to-consumer transactions such as books and music. The proposed law gives the government power to expand the definition of specified services. Further, because the levy is not a tax on income, foreign companies may not be able to claim a foreign tax credit in their country of residence, and tax treaties may not apply. There is no effective date of implementation as of yet.

Minimum Alternative Tax

In keeping with previous guidance, the bill would codify the treatment of foreign portfolio investors with respect to the Minimum Alternative Tax (MAT). MAT would not apply to foreign portfolio investors with residency in a country with which India has a double taxation avoidance agreement, and without a permanent establishment in India. Additionally, MAT would not apply to foreign portfolio investors who are residents of countries with which India does not have a double taxation avoidance agreement if the taxpayer is not required to seek registration under any corporate Indian law. This would be applied retroactively from April 1, 2001. Codification of this law provides tax relief for foreign portfolio investors as application of MAT could result in tax of up to 20 percent, including surcharges.

Capital Gains

Long-term capital gains arising from transfers by non-residents of shares in unlisted private companies will be reduced to 10 percent.  Surcharge and cesses also apply.  The change will take effect after April 1, 2016. Private equity funds will benefit from the new rule, and the reduction in rates could spur mergers and acquisitions activity in the sector. 

Dispute Resolution

The bill introduces a dispute resolution program aimed at reducing the backlog of pending direct tax litigation. It would be effective from June 1, 2016. Under the provision, the taxpayer would be required to pay the entire amount of the disputed tax. In some cases the taxpayer would also have to pay interest and penalties. Unfortunately, this program forces the taxpayer to assume wrongdoing and amounts to buying peace of mind by paying disputed tax assessments. It does not actually resolve tax issues.

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Regulatory

Foreign Direct Investment:

To boost foreign investment and facilitate the ease of doing business in India, the bill proposes several increases in allowable foreign direct investment (FDI). It also makes more sectors available to foreign direct investment through the automatic route. For example, the bill would allow 100 percent FDI in the marketing of food products produced in India under the approval route. It would also increase FDI in the insurance sector from 26 percent under the automatic route to 49 percent.  FDI in asset reconstruction companies would increase from 49 percent to 100 percent under the automatic route. While the India’s capital-starved banking sector continues to struggle, the increase in FDI caps could be a boon for investment-friendly sectors.

Bankruptcy:

The budget includes a comprehensive insolvency and bankruptcy code. According to Jaitley, the code will provide a specialized resolution mechanism to deal with bankruptcy situations in banks, insurance companies, and financial sector entities. It will be used together with the Insolvency and Bankruptcy Code 2015, which was introduced in the last legislative session, but is currently languishing in a joint committee. Together, the bills will provide a comprehensive resolution mechanism. Although the new law is expected to reform domestic bankruptcy law, it also sets the framework for developing an effective system for addressing cross-border insolvencies in India.

Corporate Bond Market:

The corporate bond market has long clamored for options contracts to add depth to the sector. The budget includes a provision to require the Securities Exchange Board of India (SEBI) to develop new products like options in the commodity derivatives market. It also includes other measures to deepen the corporate bond market; such as allowing foreign portfolio investors to invest in unlisted debt securities and pass through securities issued by special purpose vehicles.  Additionally, an individual foreign investor can hold up to 15 percent in an exchange, up from five percent, and FDI in non-banking financial companies is proposed to increase to 49 percent via the automatic route. Unfortunately, the new options also come with a proposed increase in securities transactions tax for options to 0.05 percent from 0.017 percent.  The increased securities transaction tax will raise the cost of options purchases and may impact volume. It is hoped that higher FDI will enhance global competitiveness. 

Registration of Companies:

The budget includes a bill soon to be introduced in parliament and aimed at improving the ease of doing business, including a push for company registration in just one day. Approximately 50 amendments to the Companies Act are proposed. The proposed amendments include definitions, raising capital, accounts and audit, corporate governance, managerial compensation, and companies incorporated outside India.   

Observations: While this budget shifts focus to social welfare and infrastructure expenditures, the aforementioned business elements underline many substantive financial and regulatory reforms. As India seeks greater foreign investment, increased ease of business, and sustained economic growth, the country’s leaders must work together to push through important reforms – at the same time tackling the daunting task of improving the lives of 1.2 billion people.

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