‘Cruel’ budget amendment
New Indian tax proposal will seriously affect foreign investors
WHEN presenting India’s Budget 2012-13 to the parliament on Friday, Finance Minister Pranab Mukherjee borrowed this line from shakespeare’s Hamlet: “I must be cruel only to be kind.” He was referring to economic policies that may cause short-term pain but are meant to produce benefits in the long run.
But for foreign investors in India, it may be hard to see any kindness in one particular budget proposal.
The bombshell that will impact the past, present and future investors into India is found in the fine print of the budget proposals.
In a nutshell, the finance minister is attempting to overturn a recent Supreme Court decision that held that the transfer of shares in overseas companies, which in turn hold Indian assets, are not taxable in India.
As a result of the judgement, Indian tax authorities were asked to pay back tax collected to the tune of 25 billion rupee (about Rm1.7bil) plus a 4% interest.
(The case involved Vodafone, which battled the tax authorities over the former’s 2007 acquisition of Indian mobile phone assets through an offshore deal.)
The finance minister has proposed to amend the Indian income tax law to tax the transfer of shares of overseas companies that substantially derive value from assets located in India.
This is supposed to take effect from April 1, 1962, which means going back 50 years. The legislative changes assert the state’s right to retroactively tax cross-borders share sales in which the underlying assets are located in India.
In addition to the above proposals, the provisions of withholding tax are now to be made applicable to non-residents, whether or not such non-residents have any residence, place of business or business connection in India.
If the budget proposals are passed in the current form (which is expected to occur within three months), there could be very serious consequences to multinational companies in India.
These include Malaysian companies that have sold their investments or are planning to sell their Indian investments or are proposing to carry out any internal re-organisations for a gain.
Simply put, this means a transfer of shares in a Malaysian company that holds substantial investments in Indian assets could be taxable in India under the budget proposals even though the transfer of shares takes place in Malaysia between two local companies.
A number of the proposed amendments require clarification. This would become clearer within the next two weeks.
As far as Malaysian companies are concerned, the implications of the proposed amendments have to be read together with the India-Malaysia treaty.
Or, if the Malaysian companies have invested through an intermediate country such as Mauritius, these provisions have to be reviewed in light of the treaty between India and Malaysia.
Another matter that could also have potentially serious implications to Malaysian companies is the introduction of the General AntiAvoidance Rules (GAAR) provisions in the Budget. The GAAR provisions will be effective from April 1, 2012.
As per the draft GAAR provisions, an arrangement can be termed as an impermissible avoidance arrangement if it falls under certain specified conditions. Examples of these are transactions that:
were not undertaken at arm’s length;
misuse or abuse the provisions of the Income Tax Act; lack commercial substance; or are not of a bona fide nature. The tax authorities will be empowered to determine the consequences of a transaction regarded as impermissible avoidance agreement including denying treaty benefits. The onus is on the taxpayer to prove the genuineness of the transaction.
Just like many other countries, India is veering towards adopting the doctrine of “substance over form”.
The key focus under GAAR will be for the taxpayers to prove to the Indian tax authorities that the transactions are principally commercially-driven as opposed to being primarily tax-driven.
The budget proposals will have far-reaching implications on Malaysian companies that have invested in India or are operating there.
It is time for these companies to relook and find ways to legitimately navigate themselves out of this potentially stormy situation.
Despite such aggressive legislation, the growing Indian market and its importance within Asia cannot be ignored by the investors into India. > See also page 14
Thannermalai Somasudaram is leader of India Desk Malaysia and senior executive director of PWC, Kuala Lumpur, while Aditya Narwekar is senior manager at India Desk Malaysia.