Taxing times
– The Indian financial system needs to rethink its regulatory norms
The role of the banking and financial service sector (BFS) in the process of economic development has always attracted attention. The framework of the Indian financial system needs a relook if we need to ensure unhindered credit availability to fund ambitious initiatives of the Make in India campaign.
The income tax issues faced by the BFS are ever evolving because of various tax and regulatory changes. Some of the challenges have been discussed below:
Protracted litigation
So far, foreign banks doing business through their branches in India were claiming deductions on interest payments to their foreign parent/ head office interpreting provisions of the Indian Income tax Act along with corresponding Double Taxation Avoidance Agreement (DTAA).
They considered the permanent establishment/branch as a separate and independent entity from its head office as specified in the applicable DTAA. On the flipside, they did not extend this principle while determining taxability of the same interest income in the hands of the head office. Hence, due to the absence of an enabling provision in the Income Tax Act, they were not offering this interest income to tax in India.
Further, foreign banks also contended that for the amount to be taxable under the DTAA, interest should be received on amounts representing certain “debt claims” and the claim should be effectively connected to a permanent establishment.
The Finance Bill 2015 has changed all this. Now, the Indian branch shall be deemed to be a separate and independent person from the head office.
Further, the interest payable by the Indian branch to its head office shall be deemed to accrue in India and shall be chargeable to tax in India. Also, the Indian branch has to withhold tax on such interest and failure will attract penalty.
The exchequer will be benefited as base erosion will be prevented in India. Further, the argument of payment of interest being made to self (i.e. head office) and hence not deductible will not be of any significance. This amendment is significant as the same is made into the provisions which codifies source rule under the Income Tax Act.
Under the new regime, there may be a huge burden of tax in the hands of the head office of Indian branches of foreign banks. In a developing economy like India, where raising capital is difficult and banks often borrow from headquarters of foreign banks, this move may come across as a big blow for foreign banks, who might be hesitant to extend funds to its Indian branches.
Parity for NBFCs
NBFCs form an integral part of the Indian financial system by providing risk diversification to the financial sector. The Income Tax Act of India provides certain tax benefits to banks and financial institutions but not to NBFCs, thereby resulting in an incompatible and differential treatment on various tax related matters.
Bad and doubtful debts: Banks and financial institutions are subject to a fixed deduction from the gross total income. There is no such direct tax incentive for the NBFCs. Though it is a mandatory practice of the NBFCs to create a provision for non-performing assets (NPAs) but such provisions are basically disallowed by the tax authorities while assessing their income tax liabilities.
Exemption on TDS: Interest payments made by borrowers to the lenders are subject to TDS. Companies engaged in the banking business, public financial institutions such as LIC are exempted from the purview of this section. However, NBFCs are deprived of such tax incentives and hence they are at a disadvantage vis-a-vis other financing entities.
Treatment of sticky assets: Banks have the advantage of taxing income on sticky advances only in the year they are received. However, in case of NBFCs, the authorities tax such deferred income on accrual basis, resulting in tax on income which may not be realised at all.
MAT provisions
Finance Bill 2015 proposes to amend the minimum alternate tax (MAT) provisions so as to provide that capital gains of foreign institutional investors shall be excluded from the purview of MAT.
Although this amendment will provide much needed relief to the FIIs, certain grey areas are still unaddressed such as applicability of MAT to FPIs/ FIIs which do not have a presence in India; applicability of MAT to PE investors and foreign companies (eg: income in the nature of Royalty/ Fees for Technical Services, Long Term Capital Gains on listed shares etc.) having no presence in India.
