INDIA: An Introduction to Tax

Corporate Taxation Trends in India

International Financial Services Centre

The Indian government has taken initiatives to develop an International Financial Services Centre (IFSC) to cater to overseas financial institutions and thereby facilitate transactions relating to the flow of finance, financial products, and services across borders. The IFSC is presently set up in the Gujarat International Finance Tech City (GIFT City) and offers the following exemptions.

• Cash credits in the hands of a taxpayer can be subject to higher rates of tax unless the taxpayer can explain the source of such credits to the satisfaction of the revenue authorities. Furthermore, in cases where the cash credits relate to borrowings or share capital, an additional embargo is placed on the lender/investor, who is also required to explain the source of their funds. Where such lender or investor is a venture capital fund (VCF) or venture capital company (VCC) registered with the Securities and Exchange Board of India ( SEBI), this additional embargo would not apply. By recent amendment, VCFs regulated by the IFSC Authority have also been exempted from its application.
• Section 94B of the IT Act (ie, the thin capitalisation provision) prescribes certain restrictions on the deduction of interest expense that is incurred by a borrower in relation to a debt issued by an associated enterprise. If the borrower making the interest payment is a finance company located in the IFSC, then the restriction on deduction of interest expenditure contained in Section 94B would not apply.
• Income earned by “specified funds” from transactions in securities on a recognised stock exchange in the IFSC is exempt from tax under Section 10(4D) of the IT Act. “Retail funds” and “exchange-traded funds” located in the IFSC have been included within the scope of “specified funds” to allow the benefit of exemption under Section 10(4D) of the IT Act.
• The scope of exemption under Section 10(23EE) of the IT Act has been expanded to include the “specified income” of the core settlement guarantee fund set up by a recognised clearing corporation located in the IFSC.

Limitation period fixed: failure to deduct tax on payments made to non-residents

Where any person is required to deduct taxes while paying a non-resident and does not deduct the taxes, or deducts and fails to pay the taxes, to the credit of the government, such person will be deemed to be an “assessee in default” and an order to this effect can be passed under Section 201(3) of the IT Act. The time limit for passing such an order has been reduced from seven to six years by means of a recent amendment. Although the existing provision of limitation only applies where the payee is a resident, the limitation of six years is now proposed to be extended to scenarios where the payee is a non-resident as well. Prior to the amendment, since the limitation was prescribed only to resident payees, the Indian courts had divergent views on what would constitute a reasonable time to pass an order under Section 201(3), where the payee was a non-resident. The present amendment is welcome considering the divergent rulings, and also because it brings much-needed clarity on limitation.

Abolition of the Angel Tax

Prior to the Finance Act 2024, if a company in which the public are not substantially interested received consideration for the issue of shares from non-residents and such consideration was in excess of the face value of such shares, the difference between the “fair market value” of such shares and the consideration so received was taxable in the hands of the issuer company. This tax was commonly referred to as the Angel Tax.

With effect from 1 April 2025, the said provision will no longer apply. Therefore, any capital raised by a company on or after 1 April 2025 will not be subject to the rigours of the Angel Tax. This action by the government is in the best interest of commerce since the Angel Tax, which was introduced in 2012 to curb the then-prevailing practice of laundering unaccounted monies, has become redundant in the light of specific penal provisions enacted by the government to tackle these problems. The Angel Tax therefore had a far-reaching unintended effect on genuine commercial transactions.

Equalisation levy of 2% is abolished

An equalisation levy of 2% was applicable on consideration received by a non-resident e-commerce operator from e-commerce supply or services made or facilitated by it to: (i) a person resident in India or a person using an internet protocol address from India; or (ii) to a non-resident in specified circumstances. This equalisation levy has been withdrawn with effect from 1 August 2024. However, India continues to apply an equalisation levy of 6% on online advertisement services.

Capital gains

The IT Act provides for special provisions with respect to the taxation of gains arising from the transfer of capital assets. This is dependent upon factors such as the period of holding, the nature of the asset, the tax residency of the transferor, etc. The Finance Act 2024 brought in the following key changes with respect to capital gains tax with effect from 23 July 2024:

• Only two minimum holding periods, ie, 12 or 24 months, have been stipulated to classify a capital asset as short term and long term, respectively.
• Gain on the transfer of equity shares, units of an equity-oriented mutual fund and of a unit of business trust which has suffered securities transaction tax (STT) and been held for 12 months or less will be subject to tax of 20% as against the existing rate of 15%. If the same is held for more than 12 months, the rate of tax would be 12.5% as against the existing rate of 10%.
• Tax on the transfer of unlisted shares in the hands of non-resident shareholders increased from 10% to 12.5%. The benefits of currency translation provided in the first proviso to Section 48 will not be available.
• The income of a non-resident by way of interest on bonds from an Indian company, long-term capital gains from the transfer of bonds, or global depositary receipts (GDRs) will be subject to a tax of 12.5% as against the existing rate of 10%.
• The rate of tax on gains from the sale of immovable property which was taxable at 20% (with an indexation benefit) has been lowered to 12.5% (without an indexation benefit). The amendment was grandfathered for transfer of an immovable property acquired prior to 23 July 2024. However, this benefit is not available to non-resident transferors.

Buyback of shares

In the case of the buyback of shares by a company, the difference between the consideration paid by the company to its shareholders for the buyback and the amount received by the company for the issue of such shares was taxable in the hands of the company at a rate of 20% with an exemption granted to the shareholder. In the Finance Act 2024 the taxation of buyback is sought to be brought in line with the taxation of dividends, and the burden to discharge tax is shifted to the hands of the shareholder. No deduction for any expenses will be available to the shareholder. They can, however, claim the cost of shares bought back as capital loss offsetting gains from other share sales.

Judicial trends

The sanctity of tax residency certificates (TRCs) issued especially by tax-friendly jurisdictions is generally questioned so as to investigate the possibility of tax avoidance/evasion. In a recent decision of the Delhi High Court in Tiger Global International III Holdings [(2024) 165 taxmann.com 850 (Delhi)], it was held that the issuance of a TRC by a competent authority must be considered sacrosanct and the entity holding said TRC must be considered to be pursuing a legitimate business purpose in that country. Further, it was held that the establishment of investment vehicles in tax-friendly jurisdictions cannot give rise to a presumption of tax evasion or treaty abuse. The issue with respect to the sanctity of a TRC has not yet attained finality, since a similar issue is agitated by the Income Tax Department (the "Department") and pending before the Supreme Court in the case of Blackstone Capital Partners. In this case, the Delhi High Court held that the Department cannot go behind a valid TRC to deny capital gains tax exemption of shares acquired prior to 1 April 2017, as provided under Article 13(4A) of the India-Singapore double taxation avoidance agreement (DTAA), on the ground that the taxpayer is not a beneficial owner.

A full bench of the Delhi High Court in Hyatt International Southwest Asia Ltd [(2024) 166 taxmann.com 466 (Delhi)] decided on the issue of whether profits attributable to an Indian PE company can be taxable in India even if the entity incurs financial losses at the global level. The Delhi High Court ruled in favour of the Department and held that a PE firm was to be treated as a separate and independent entity in the capacity of the global entity with respect to profit attribution, regardless of profits or losses incurred at a global level. Profits generated locally could be taxed, irrespective of the enterprise’s global financial performance. The Delhi High Court distinguished this case from its earlier decision in Nokia Solutions and Networks OY, wherein the court ruled that no profit attribution was warranted if the global entity had incurred a loss.