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Date:21^st July 2010	Compiled by: M Sathya Kumar
Impact of revised Code on financial services The proposal to levy tax on the basis of book profits would come as a major relief for the industry After considering feedback from the industry and the taxpayers on the draft Direct Taxes Code (DTC) released in August last year, a Revised Discussion Paper (RDP) on DTC was released by the Government on June 15 for public comments till June end. The major impact of RDP on various financial services sector is discussed below. Banks, NBFC MAT rollback: As against asset-based tax, the revised proposal is to levy a tax on book profits. In the proposal there is no clarity on the MAT rate, but the rate of 18 per cent as introduced in this year's Budget may be the benchmark. Though the original proposed rate of tax for banks was much lower at 0.25 per cent of gross assets as compared to 2 per cent proposed for other companies, the banking industry was not comfortable with it. NBFCs found the tax rate of 2 per cent of gross assets simply not workable considering the margins on which the industry operates. The proposal to levy tax on the basis of book profits would come as a major relief for the industry. Treaty override: The original proposal suggested that the tax treaties could be overridden by a provision in the domestic law brought in later in time. This had given rise to apprehensions regarding several issues relating to application of treaty benefits. These override provisions have been proposed to be rolled back partially. The RDP has clarified that the existing position of the more beneficial provision between Indian domestic law and treaty being applicable to a taxpayer will continue. However domestic law will prevail when General Anti-avoidance Rules (GAAR), Controlled Foreign Corporation (CFC) provisions are invoked and when branch profits tax is levied. This amendment could have a significant impact on Indian banks having subsidiaries abroad in which case CFC rules would apply and the foreign banks having branches in India which would be subject to branch profit tax in India. Residency test: It is proposed to introduce the concept of “effective control and management" to test the residency of a foreign company rather than on the basis of 'part control' concept in the earlier draft. Application of test of effective control and management which is based on the location of the meeting of the board of directors, could pose practical difficulties. If a foreign company is regarded as a resident in India it will face serious tax exposures in India. CFC: The proposal has introduced the CFC provisions, whereby the passive income of overseas subsidiaries would be taxable in the hands of the Indian parent, despite the said income being not distributed by the overseas subsidiary to the Indian parent. This will clearly impact Indian banks having subsidiaries overseas. One would have to wait for the fine print to see whether other industry issues around tax treatment of NPA and interest on such loans, lower withholding for NBFCs, transaction s between head office and branches, taxability of offshore loans for Indian investments, etc are resolved. Insurance industry Like NBFCs, the insurance industry found the original provisions on MAT simply unworkable. Apart from MAT rollback, the other key proposal that would impact the industry is the proposal that the current favourable tax treatment for pure life insurance products and annuity schemes will continue at the time of investment, during the holding period as well as on withdrawal. However, ULIP policies would not be covered under this regime. The RDP clarifies that “investments made” prior to DTC becoming effective would continue to enjoy the benefit for full duration. However, there is no mention of the tax issues currently being faced by the industry surrounding taxation of surplus in shareholders account and the policyholders account. FIIs Characterisation of income: To end the ongoing debate surrounding the characterisation of income of FIIs from trading in India, the RDP proposes that income of FIIs from buying and selling of Indian securities would be treated as “capital gains” and not "business income”. Further, there will be no withholding tax in respect of capital gains earned by FIIs as was proposed in the DTC initially. The clarification on withholding tax would be welcomed by the FIIs since withholding tax provisions could not have been complied with for transactions on the stock market. As regards characterisation issue one needs examine whether one could invoke treaty provisions to continue to claim characterisation of income as business profits. Taxation of capital gains: Currently there is no tax on listed shares sold after holding for a period of one year and the short-term gains attract tax at the rate of 15 per cent. All the capital gains are not proposed to be taxed at the rates application to corporate and non-corporate FIIs. The rates are yet to be notified. The proposal recognises the difference in taxation of short term and long term capital gains, as under the current law. However, determination of the holding period for classification of asset as long term asset is proposed to be 1 year from the end of financial year in which the asset is acquired vis-à-vis the current period of 1 year from date of acquisition of asset. This could effectively mean a holding of almost 24 months if a security is bought in the beginning of the financial year. The long term gains would be entitled to a deduction to be specified. Security Transaction Tax: Securities Transaction Tax which was proposed to be abolished under the DTC proposals last year will now continue, albeit in a revised manner to be notified separately. The treaty override provisions discussed earlier could affect FIIs investing through a third country like Mauritius if the general anti avoidance provisions are applied. Mutual fund industry The tax benefit currently available to investors on investment in the equity-linked saving scheme would not be extended which could impact the industry which is already facing stiff competition from insurance and pension industry. The DTC makes no mention of the overall tax regime for the fund and the investors and hence the issues around pass through status and taxability of investors have not been resolved. General provisions GAAR: The GAAR provisions are retained albeit in a diluted form. GAAR can be invoked in circumstances such as transactions lacking commercial substance. The CBDT is expected to issue guidelines on circumstances under which GAAR can be invoked. The threshold limit for invoking GAAR and dispute resolution panel provisions will, however, be introduced. The clarifications provided in the RDP do come as a welcome measure. While the RDP has clarified several concerns that taxpayers had raised in relation to the initial proposals, other DTC provisions on which concerns were expressed, such as taxation of indirect transfers, withholding tax provisions, pass-through status of investment pooling vehicles etc., are not addressed. One would need to await the Bill to be introduced in Parliament to understand how the Government seeks to address the concerns raised on these provisions of the DTC. Article by Sunil Gidwani, The author is Executive Director - Tax and Regulatory Practice, PricewaterhouseCoopers.
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