m/in sharing insights dtc 2009 proposed to replace the income-tax act, ... • the dtc should...

1

Report of the Standing Committee on Finance on DTC 2010 – Analysis of key recommendations

In 2009, the government released the Direct Taxes Code 2009 (DTC 2009) along

with a discussion paper. The DTC 2009 proposed to replace the Income-tax Act,

1961 and the Wealth-tax Act, 1957.

After receiving several representations from across stakeholders, the government

issued a revised Direct Taxes Code 2010 (DTC 2010). The DTC 2010 addressed the

issues and concerns raised by various stakeholders. The DTC 2010 was referred to

a Standing Committee on Finance (the Committee or SCF) headed by the former

Finance Minister, Mr. Yashwant Sinha.

The Committee prepared a report providing its recommendations after collating

the representations made by various stakeholders and the response of the Ministry

of Finance (MoF). The report was released recently.

The Alert contains the key provisions relevant for both residents and non-

residents. The response of the MoF and the recommendations of the Committee

provide clarity and are indicative of the forthcoming approach that can be expected

in the final version of the Direct Taxes Code to be released.

www.pwc.com/in

Sharing insights

News Alert 15 March, 2012

PwC News Alert

March 2012

1Independent bodies include CII, ICWAI, Bombay Chartered Accountant’s Society, Indian Banks’ Association, Bombay Chamber of Commerce and Industry and others.

2

Provisions in the Direct Taxes Code (DTC) Recommendations from Independent Bodies1

and Ministry of Finance’s (MoF) response

Observations/Recommendations of Standing

Committee on Finance (the Committee or SCF)

Place of Effective Management in India (POEM)

• Foreign companies are to be treated as

‘resident’ in India if their Place of Effective

Management (POEM) in India, at any time in

the year, is in India.

• POEM has been defined to mean :

- the place where the board of directors

(BoD) of the company / its executive

directors make their decisions; or

- in cases where the BoD routinely

approves the commercial and strategic

decisions made by the executive directors

or officers of the company, the place

where such executive directors or officers

of the company perform their functions.

[Sections 4(3), 314(192)]

Recommendations from Independent Bodies

• The company should be resident in India only where

it habitually takes strategic decisions in India, it is

effectively managed in India.

• The definition of residency as contained in Direct

Taxes Code (DTC) may lead to increase in instances

where a single company may be considered to be a

resident of two countries. This would lead to

taxation of global income of the said company in two

countries

• The DTC should provide for detailed guidelines on

tie breaker test with a defined timeline for

application of the process of the tie-breaker test.

• The DTC should contain guidelines for establishing

a POEM.

• The words adjacent to POEM ‘at any time in the

year’ should be deleted.

MoF response

The MoF has stated that it would consider

recommendations in relation to,

• Obviating situations of a single company becoming

resident of two countries.

• Issuing guidelines for establishing a POEM.

• Several aspects of the definition of POEM are unclear

and provide room for uncertainty in following

situations:

- Executive Director is not defined and would lead to

ambiguity.

- The expression ‘officer’ would lead to

ambiguity/uncertainty as in these times,

commercial and strategic decisions are made at

various levels.

• Determining POEM on the basis as to where such

officers perform their functions is not an objective

criteria of deciding fiscal residency.

• Reference to Executive Directors (ED) or officer may be

removed from the definition of POEM and residency

should instead be determined on the basis of

internationally accepted standards and judicially

settled principles,

- where the focus is on the place,

- where the key management and commercial

decisions as a whole are made, or,

- where the ‘head and brain’ of the company is

situated.

PwC’s Comments

• Broadly, the recommendations of Independent bodies have been favourably considered by the committee.

• The committee has appreciated the possible conflicts arising out of the definition contained in the DTC.

PwC News Alert

March 2012


3

Provisions in the Direct Taxes Code (DTC)

Recommendations from Independent Bodies1 and Ministry of Finance’s (MoF) response

Observations/Recommendations of Standing Committee on Finance (the Committee or SCF)

Indirect transfer (IDT)

• The income from the transfer outside India

of any share or interest in a foreign

company shall be tax exempt, provided that

in the 12 months preceding the transfer, the

fair market value (FMV) of the assets

owned by the company in India, directly or

indirectly, represents less than 50% of the

FMV of all assets owned by the company.

• The term ‘asset’ as defined by the DTC

includes business assets and investment

assets, including intangible assets, for the

purpose of determining the FMV.

• For a non-resident, a formula is provided

for computation of income accrued in India,

arising out of transfer outside India. [Sections 5(4)(g) & 5(6)]


• Since the GAAR provisions encompass even indirect

transfer of capital assets outside India, specific

provisions to tax the same should be excluded from

the DTC.

• The provisions of ‘indirect transfer’ should not be

applicable when the :

- Where the primary objective of the transfer is not

to avoid tax in India.

- In case of overseas restructuring of group

companies outside India.

- The transactions involve less than 50% of shares

or interest of the foreign company ; or

- Transactions done on a stock exchange outside

India.

• Criteria for computing the FMV of the assets could

be applied on a particular date instead of at any time

during the 12 months preceding the transfer.

• For the purpose of applying the 50% parameter, the

value of ‘all assets directly or indirectly owned by

the company’ should be considered.

• The provisions of ‘indirect transfer’ should be

applied only on ‘direct transfer’ of the shares of the

foreign company. ‘Indirect transfer’ of shares in, or

interest of, a foreign company should not result in

any Indian tax liability i.e. the shares of an

• Exemption should be provided to transfer of small

shareholdings and transfer of shares listed outside

India.

• The criteria for computing FMV of assets any time

during 12 months preceding the transfer date is

onerous, and hence, comparison be made as per the

last balance sheet date.

• Exemption may be provided to intra-group

restructuring outside India, as the DTC itself exempts

such transactions from capital gains.

PwC News Alert

March 2012


4

Provisions in the Direct Taxes Code (DTC)

Recommendations from Independent Bodies1 and Ministry of Finance’s (MoF) response

Observations/Recommendations of Standing Committee on Finance (the Committee or SCF)

Indirect transfer (IDT)

intermediary foreign company should not be taxed

under these provisions.

• Comparison to be restricted to latest available

audited balance sheet and the onus to prove that tax

liability is triggered should be on the tax

department.

MoF response

• The income has to be first covered within the scope

of total income and then only it can be brought to

tax by invoking the anti-evasion provisions.

• The date of valuation would be considered for

transfer of small holdings.

• The provisions are intended to outline the source

rule with regard to indirect transfer of assets

situated in India. PwC’s Comments It is necessary that the provisions relating to indirect transfer are revisited and introduced in a manner to be fair and workable as per the recommendations made by the independent bodies and the Committee.

Provisions in the Direct Tax Code (DTC) Recommendations from Independent Bodies1




General Anti Avoidance Rule (GAAR)

• General Anti Avoidance Rule (GAAR)

provisions would override tax treaty

provisions.

• GAAR empowers tax authorities to declare


• Suitable safeguards must be built in to ensure that

GAAR is applied in appropriate cases. GAAR

Observations

• The committee observes that GAAR proposals seek to

empower the income tax authorities, namely the

PwC News Alert

March 2012


5






any transaction as impermissible and

determine the tax consequences, if the

transaction has been entered into with the

main object of obtaining a tax benefit and if

it lacks commercial substance.

• The provisions cover aspects such as the

interposition of an entity, the piercing of

the corporate veil, round-trip financing and

thin capitalisation.

• The onus to prove that tax avoidance is not

the main purpose of a transaction shifted to

the tax-payer.

• Situations resulting in a reduction in the

tax base, including an increase in loss, can

attract GAAR provisions.

• The GAAR provisions will be applied to all

parties to a transaction if they are

applicable to any of the parties to the

transaction.

• The definition of an arrangement suggests

that if a tax benefit is the sole purpose

under an arrangement, then it would be

regarded as an impermissible avoidance

arrangement.

[Sections 123,125, 154, 291(9)]

should be administered by an independent panel

unlike the current Dispute Resolution Panel (DRP).

• GAAR will not apply to such arrangements which

can reasonably be considered to have been

undertaken primarily for genuine purposes.

• GAAR should not apply to transactions already

completed prior to the date of enactment of the

DTC

• GAAR should not apply to transactions which were

subject matter of a ruling given by the Authority for

Advance Rulings (AAR).

• GAAR override should not apply to treaties which

already have the ‘limitation of benefit’ clause.

• The definition of the term ‘impermissible

avoidance arrangement’ be replaced.

• It should be clarified that if a tax benefit has been

derived by virtue of a tax treaty provision and such

tax treaty already contains a specific provision to

prevent abuse of the tax treaty, the GAAR should

not be applied overriding such anti-abuse

provisions of a treaty.

• The terms ‘commercial substance’ and ‘bona fide

business purpose’ should be defined in an

exhaustive manner as the current definition could

result in some degree of subjectivity and ambiguity

in its application.

• An independent authority comprising of members

who have judicial experience including

Commissioners to invoke the applicability of the

provisions and shifts the onus to the taxpayer. The

Ministry has stated that appropriate guidance for

applying these provisions will be provided to tax

authorities through guidelines. The Committee finds

the following serious concerns which need to be

addressed:

- GAAR confers vast and discretionary powers to

tax authorities to disregard any business

transactions and which would lead to significant

uncertainty with respect to conducting business in

India.

- A tax treaty override (without any objective

parameters) under GAAR could raise concerns

about the sanctity of benefits conferred under

treaties and affect India’s credibility as a reliable

treaty partner.

- The DTC does not contain any ‘grandfathering’

provisions to cover structures that are currently in

place

- The application of GAAR to a specific structure by

the tax authorities could change from year to year,

resulting in significant fiscal uncertainty.

- Transactions/structures that have been

specifically upheld by Courts could also

potentially be targeted under the GAAR.

- GAAR could lead to cumbersome, time-

consuming and costly litigation each time a

PwC News Alert

March 2012


6






businessmen and professionals of experience

should be constituted for objectively reviewing and

approving all cases proposed by a Commissioner of

Income-tax (CIT) for invoking GAAR.

• GAAR should provide for a maximum period (say,

12 months from date of filing of tax return) within

which the CIT should seek to invoke GAAR

• The threshold limit for invoking GAAR should be

reasonable.

• The tax authorities should be restricted from

invoking the provisions of GAAR during the course

of reassessment proceedings and should also be

prohibited from initiating reassessment

proceedings by invoking GAAR.

• GAAR provisions should not apply in cases where a

transaction/arrangement has been approved by a

High court or a Supreme Court.

MoF response

• Conditions and the manner under/in which GAAR

would be applicable be prescribed through Rules.

• Using the phrase ‘genuine purposes’ would create

ambiguity as this phrase is difficult to define. On

the other hand, the four criteria mentioned in

clause 134(15) would in themselves exclude a

genuine transaction.

• The MoF accepts that GAAR would not apply to

transactions prior to enactment of the DTC while

transaction or structure is sought to be tested

under the GAAR by the tax authorities.

Recommendations

• The onus should rest on the tax authorities to invoke

GAAR and this should not be shifted to the taxpayer.

• Uncertainties with regard to applicability of tax treaty

provisions should be removed so that India’s

credibility as a reliable treaty partner is not affected.

• The MoF and the Central Board of Direct Taxes

(CBDT) should seek to bring greater clarity and

preciseness to the scope of the provisions. There

should be certainty on these provisions so that foreign

investors do not become wary of investing in the

country.

• The conditions dealing with ‘misuse or abuse of DTC

provisions’ and the ‘manner applied for the

arrangements not for bona fide business purpose’ and

‘lacks commercial substance’, being very widely

worded and subjective, need to be more specifically

defined to avoid undue discretion to tax authorities.

• A threshold may be prescribed under the Rules to

cover small cases which should be outside the purview

of GAAR.

• It has been proposed that the orders of the

Commissioner invoking GAAR provisions will be

subject to approval of DRP which is a collegium of

PwC News Alert

March 2012


7






prescribing guidelines.

• The AAR gives rulings only in cases where the

transaction is not part of the avoidance

arrangement.

• Limitation of benefit clause as available in India’s

Tax treaties has limited application and would not

cover all the cases/circumstances which would be

covered through GAAR.

• The suggestion in relation to changing the

definition of the term ‘impermissible avoidance

arrangement’ is not acceptable as the definition

provided in the DTC is based on international

practice. The suggested definition would make all

conditions unilateral which would narrow the

scope of the provision to such an extent so as to

make it ineffective as an anti avoidance tool.

• GAAR provisions will check treaty shopping by tax

payers for avoidance of payment of tax in India.

CFC being anti-deferral measure is applicable in

limited number of cases involving foreign

companies. The definitions of ‘commercial

substance’ and ‘bona fide purpose’ are based on

international practices.

• GAAR provisions will be invoked by the

Commissioner who is a senior functionary of the

Department. Besides, the orders will be subject to

approval of DRP, a collegium of three

Commissioners. There would be adequate

three Commissioners of Income tax.

• The DRP should be headed by a Chief Commissioner

of Income-tax and two other members who should be

independent technical persons.

• GAAR provisions should apply prospectively so that it

is not made applicable to existing

arrangements/transactions. Alternatively, suitable

grandfathering provisions may be made to protect the

interest of the taxpayers who have entered into

structures/arrangements under the existing law.

• Tax-payers may also be permitted to obtain an

advance ruling to determine whether any kind of

transaction would be covered by GAAR.

• While invoking GAAR provisions, the entire

arrangement may be declared as an ‘impermissible

arrangement’. It should be clarified that only that part

of the arrangement would be invoked which is

considered as ‘impermissible’.

• The proposals should not lead to any fiscal

uncertainty or ambiguity. It should be ensured that

any of the proposals does not pave the way for

avoidable litigation, which is already at a very high

level in tax matters.

• The guidelines to address concerns on GAAR should

be laid in the Parliament along with the duly amended

DTC Bill.

PwC News Alert

March 2012


8






safeguards built into the system when the

conditions and circumstances are prescribed. This

should allay such apprehensions

• Such a time limit cannot be provided as the tax

avoidance arrangement may pertain to more than

one year. The tax authorities are required to invoke

provisions of GAAR as and when relevant

information comes to its notice.

• The Ministry has accepted to consider bringing in

the threshold limit to invoke GAAR while framing

guidelines.

• As GAAR is intended to deal with impermissible

avoidance arrangements, which may have impact

over several years, placing this type of restriction is

not feasible.

• The approval of High Court or Supreme Court is

with specific objective and may not take into

account tax avoidance issues and circumstances

which are relevant at the time of invocation of

GAAR.

• There is no need to defer the implementation of

GAAR. Since GAAR would be operational under a

set of guidelines framed by CBDT, there should be

no cause for concern in this regard.

PwC’s Comments

The Committee has recommended very pragmatic and favourable provisions for the GAAR framework. It is hoped that the GAAR provisions, when introduced, are

based on the recommendations of the Committee.

PwC News Alert

March 2012


9





Minimum Alternate Tax (MAT)

• Minimum Alternate Tax (MAT) is

proposed to be levied at 20% on the book

profit

• Book profit has been defined to mean

profit as per profit and loss account

adjusted for items on same lines as the

current provisions contained in section

115JB of the Income-tax Act (the Act)

• Every company shall prepare its profit and

loss account for the relevant financial year

in accordance with the provisions of Parts

II and III of Schedule VI to the Companies

Act, 1956.

• The provisions give the manner in which

tax credit for a financial year, arising due

to payment of income tax on book profit in

such year is to be calculated and carried

forward and allowed set-off in succeeding

years.

[Section 104(1), Second Schedule]


• MAT should not be levied on companies eligible for

claiming investment based incentives. A waiver be

provided on such companies in the initial years.

• Investment companies should not be subject to

MAT or provided concessional tax treatment as

their only source of income is investment income.

• Every company should be allowed to set-off entire

book losses being subject to MAT.

• Insurance companies (also banks and electricity

companies) should be out of the purview of MAT as

they are not required to prepare their profit and

loss account as per the Companies Act, 1956.

• Special Economic Zones (SEZ) units/developers

should not be made subject to MAT.

• MAT credit balance under the Act should be

grandfathered and allowed to be carry forward for

the unexpired period that is eligible for set-off.

• MAT credit should be allowed to be carry forward

at the time of conversion of a company into a

limited liability partnership (LLP).

MoF response

• The MoF did not accept the suggestions relating to

providing relief to companies claiming investment

linked incentives.

• The current law is also changed in regard to levy of

MAT on SEZ units/developers and hence, the

• The committee has recommended that service

companies be allowed set-off of loss and depreciation

both and then be subjected to MAT.

• The SCF recommended suitable

amendments/rectifications to enable banks and

electricity companies to be out of the purview of MAT.

• It is recommended that appropriate grandfathering

provisions be introduced in the DTC Bill for SEZ

units/developers being made eligible for the balance

period of exemptions.

• MAT credit should be grandfathered and carried

forward under the new legislation for set-off against

MAT payable.

PwC News Alert

March 2012


10





Minimum Alternate Tax (MAT)

suggestion was not accepted.

• Grandfathering of MAT credit would be

considered.

• There is no justification to allow carry forward and

set-off of MAT credit to an LLP as the status of

business organisation changes from a company

into an LLP. This is not accepted even under the

current law.

PwC’s Comments

Most of the recommendations have been accepted by the Committee.

Provisions in the Direct Taxes Code

(DTC)

Recommendations from Independent Bodies1




Controlled Foreign Companies (CFC)

• The total income of the resident company

for the financial year (FY) would include

income that is attributable to a Controlled

Foreign Companies (CFC).

• For a company to conform to the definition

of a CFC, it should be a resident of a

territory with lower rate of taxation.

• Territory with a lower rate of taxation

means a country or a territory outside

India in which the amount of tax paid

under the laws of that country or territory


• To avoid double taxation of income of CFC, all

dividends be excluded from the profits for the

purpose of computation.

• The clause defining ‘dominant influence’ or

‘decisive influence’ be removed as it provides

avoidable discretion to the assessing officer (AO).

• The 50% control test would be restricted to cases of

individual who owns more than 10% voting right

and owns more than 50% collectively with others

acting in concert.

• Suitable amendment be made in proposals dealing with

the territory with lower rate of taxation to clarify that

foreign tax credit in respect of actual tax paid in any

other territory would be included in the tax paid.

• The control tests prescribed define the terms such as

‘directly or indirectly’, ‘dominant influence’ and

‘decisive influence’. They require to be more precisely

defined in scope to avoid ambiguities and unnecessary

litigation. It should be clarified that the attributable

income of the persons resident in India and exercising

control over the CFC should be the amount of current

PwC News Alert

March 2012


11


(DTC)






in respect of profits of a company that

accrue in any accounting period, is less

than one-half of the corresponding tax

payable on those profits computed under

the DTC, as if that company was a domestic

company.

• A foreign company is not treated as a CFC

if it is engaged in any active trade or

business. The concept of active trade or

business has been elucidated whereby not

more than 50% of the foreign company’s

income should have been derived from, (i)

dividends, (ii) interest, (iii) income from

house property, (iv) capital gains, (v)

annuity payments, (vi) royalty, (vii) sales to

related / associated enterprises, (viii)

income from management of securities,

etc.

• The definition of CFC includes one or more

persons exercising control over a CFC,

whether individually or collectively. The

term ‘control’ is defined to include

dominant influence due to a special

relationship or sufficient votes to exercise

dominant influence in a shareholders

meeting.

• The definition of passive income also

includes related party transactions.

• Clarification is required for the context of the

determination of control test linked to capital and

which should not include loan creditors.

• Applicability of the CFC refers to ‘amount of tax

paid’, in the context of ‘territory with a lower rate of

taxation’ the reference should be to ‘tax rate’,

instead of to ‘amount of tax paid’. Clarification

required in relation to ‘tax payable’ in offshore

jurisdiction that it would be the effective tax rate

after taking into account any foreign tax credit in

that jurisdiction.

• Comparison at income level is inappropriate as

otherwise it may cover even loss making companies

having passive income.

• Unfair to include companies that have set-up global

sourcing or distribution companies for business

purposes and not for tax considerations.

• ‘Motive’ test should be prescribed to decipher

whether CFC regulations are triggered.

• The provisions of CFC should not be triggered

where distribution of income is not permissible in

the foreign jurisdiction.

• On consolidation of income, the loss of CFC should

be allowed to be clubbed and set-off against the

profits of the income company. Also, provisions for

carry forward and set-off of losses incurred by CFC

in the hands of the Indian company be permitted.

• CFC regime be deferred as Indian outbound

profits of a CFC, which are capable of being distributed

as per the applicable laws of the foreign country.

• Since the triggering points to invoke CFC regulations

are so many that cumulative or combined trigger of two

or three points/criteria ought to be stipulated instead of

a single-point trigger.

PwC News Alert

March 2012


12


(DTC)






• Where the income attributable to a CFC is

a loss as per the computation provisions,

the provisions as worded do not specifically

allow the loss to be set-off in the hands of

the Indian holding company.

[Sections 5, 113(2)(k), 291, Twentieth

Schedule]

investment is still at a nascent stage.

MoF response

• Underlying tax credit, if any, to be granted as per

the country specific tax treaty. Therefore, cannot be

provided as a general rule in domestic law.

• Current year’s CFC attributed to resident

shareholders, hence dividend paid from current

year’s profit is allowed as deduction and earlier

years’ dividend is disallowed.

• Internationally, in addition to the objective test, the

subjective test is required as the threshold of

exercising dominant influence differs from

jurisdiction to jurisdiction. In appropriate cases,

CBDT has powers to issue circular for guidance of

AO.

• One of the criteria to be a CFC is that company’s

shares are unlisted. Such companies are generally

controlled by one or two groups through multitude

of relatives and entities, and the condition of 10%

individual holding can easily be circumvented. In

such instances, the condition of joint or multiple

ownership exceeding 50% to define control over a

corporation is most appropriate legislation.

• It is clarified that tax paid in any other territory

would be treated as tax paid for foreign tax credit.

• Manufacturing company may not have any

attributable profits and even if there are profits, the

PwC News Alert

March 2012


13


(DTC)






income threshold provided would take care of such

small income or in cases of companies having long

gestation period.

• Internationally, such provisions are adopted to

prevent tax planning through use of base

companies. Transfer pricing is applicable to

prevent shifting of excess profits and does not

provide for expediting repatriation of profits.

• The motive test is inbuilt in the provisions and

where the entity fails the active business test then

only it is treated as CFC. The active business test in

its ambit has motive test as the underlying idea.

Safe harbour provisions would be considered to

take care of exceptional circumstances.

• In the current scheme of taxation, the loss of a

subsidiary cannot be clubbed with the holding

company as there is no concept of group taxation in

India.

• It will not hamper either the competitiveness or the

investment potential of Indian corporates. The

applicability of CFC rules is triggered only when the

entity is situated in a tax haven or in a very low tax

jurisdiction. Most of the developed and developing

countries, which are a preferred destination for real

business activity, would remain out of the scope of

CFC.

PwC News Alert

March 2012


14


(DTC)






PwC’s Comments

The Committee has recommended very pragmatic and favourable provisions for CFC framework. It is hoped that the CFC provisions, when introduced, are as

recommended by the independent bodies and the Committee.


(DTC)





Branch Profit Tax (BPT)

• A foreign company, in addition to

income-tax payable, shall be liable to BPT

on its branch profits at 15%.

• Branch profits would be the income

attributable, directly or indirectly, to the

Permanent Establishment (PE) or an

immovable property situated in India.

[Section 111, 291(9)]


• The method of computing BPT be amended to

provide for levy only on profits repatriated out of

India by the PE instead of it being a levy on the

income attributable to the PE.

• Levy of BPT should be on profits and not on gross

receipts as the expression income is largely defined

as gross receipts.

• It should be clarified that BPT is in the nature of

income-tax so as to enable foreign companies to

claim tax credit under the tax treaty.

• The BPT should be restricted to a foreign company

that establishes a branch in India and which is

registered under part XI of the Companies Act 1956.

• It should be clarified that BPT would be levied on a

consolidated basis in case of multiple branches and

not on a stand-alone basis.

• BPT should not be levied on the PE of an entity

which is subject to presumptive taxation.

• It should be clarified that the concept of a branch and a

PE be aligned with bilateral tax treaties/agreements for

direct tax purposes. This will enable foreign entities to

avail tax credit under their domestic law.

• The BPT provisions should bring in equality between

domestic and foreign companies.

PwC News Alert

March 2012


15


(DTC)





Branch Profit Tax (BPT)

MoF response

• BPT is not a remittance tax and is to be levied at the

first point when income is earned.

• Liability of BPT is on computed total income under

the DTC and would be computed after allowing

available deductions.

• The BPT is in the nature of income-tax and tax

credit would be available the tax treaties.

• The concept of a branch is aligned with that of a PE

as contemplated in various tax treaties entered into

by India with other countries.

• Since total income is that of an assessee, the income

of all the PEs would get clubbed. Thereafter, income

payable would be reduced and branch profits

worked out for levy of BPT.

• There is no justification to exempt presumptive

income as it is only one mode of computation. It

does not alter the character of income of the PE.

PwC’s Comments

• Levy of of BPT on full amount of branch profits would be improper where the same are retained in India.

• Levy of BPT only on profits repatriated outside India should be considered.

PwC News Alert

March 2012


16

Provisions in the Direct Tax Code

(DTC)




Committee of Finance (the Committee or SCF)

Definition of the term ‘associated enterprise’

• Two additional parameters have been

proposed to be introduced by the DTC in

section 124(5) of the DTC whereby two

enterprises, shall be deemed to be

associated enterprises (AEs) at any time

during the financial year, if they are

associated with each other by virtue of:

- the services provided, directly or

indirectly, by one enterprise to

another enterprise or to persons

specified by the other enterprise, and

the amount payable and the other

conditions relating thereto are

influenced by such other enterprise

[Section 124(5) (x)];

- any specific or distinct location of

either of the enterprises as may be

prescribed [Section 124 (5)(xiv)].


• In order to avoid arbitrariness in interpretation of

section 124(5) (x) of the DTC, and similar to section

125(5)(viii) of the DTC2, a threshold of ninety

percent of total services provided by the service

provider should be incorporated.

• The following recommendations were made on

section 124(5)(xiv) of the DTC

- Merely transacting with parties in a specified

location should not be the basis of making the

transacting parties to be associated.

- There may be hardships for the taxpayer

because the provision aims to scrutinise

genuine commercial transactions between

unrelated parties where there may be no real

motive or ability for a taxpayer to shift profits

overseas effectively as the beneficiary in this

case would be an entity that has no nexus with

the taxpayer. The Government should

therefore clarify its intent in introducing this

provision.

- A monetary threshold for granting exemption

from this provision should be prescribed in

order to avoid small and economically

insignificant transactions falling within the

ambit of the Transfer Pricing legislation.

- There may be practical difficulties in obtaining

details about the transactions of enterprises in

• The Committee did not provide any comments on the

recommendations to section 124(5)(x) of the DTC.

• However, as regards section 124 (5)(xiv), the

Committee acknowledged that the proposed

regulation was an anti-abuse measure to prevent tax

evasion and made the following specific comments

- Hardship to tax payers should be avoided by

excluding purely commercial transactions

between unrelated parties, from the purview of

this section.

- A monetary threshold may also be prescribed for

granting exemption from these regulations to

small and economically insignificant transactions.

2Which is similar to existing provisions under section 92A(2)(h) of the Indian Income Tax Act, 1961.

PwC News Alert

March 2012


17


(DTC)






specified locations.

MoF response

• W.r.t. section 124(5)(x) of the DTC, the MoF stated

that services cannot be equated to a transaction

involving raw material purchases. In any case, two

enterprises will not be categorised as AEs unless

the amount payable and conditions relating to the

services are influenced by the other enterprise.

• On section 124(5)(xiv), the MoF did not accept the

suggestions as the introduction of this section was

an anti-abuse measure so as to prevent tax evasion,

and a counter measure to deal with non-

cooperative jurisdictions.

• Since the assessee would be having transactions

with parties in the notified jurisdictions, it may not

be too difficult for it to gather requisite

information.

PwC’s Comments

Section 124(5)(x)

• Section 124(5)(x) is very similar to the previous sub-section, i.e., section 124(5)(ix), which is in fact identical to the existing section 92A(2)(h) of the Income-tax

Act, 1961 (the Act).

• The primary difference in the abovementioned two sub-sections of the DTC is that section 124(5)(ix) deals with manufacturing/ processing activities, while

section 124(5)(x) now stands to also cover service activities, which were not earlier covered in the Act.

Undoubtedly, the definition under section 124(5)(x) is very wide, however, practically speaking, most entities that would fall under the ambit of this definition may

have anyways been covered under at least one of the definitional criteria prescribed in section 124(5) of the DTC.

PwC News Alert

March 2012


18


(DTC)






Therefore, effectively, the practical impact of introducing this definitional criteria may not be very significant.

Section 124(5)(xiv)

• Going by the MoF’s response, it seems that the Government would retain section 124(5)(xiv) of the DTC. However, though the objective of this section is to arrest

any tax avoidance, the location of enterprises by itself may not be an indicator of such avoidance unless other clearly measurable parameters are set out.

Therefore, if the suggestion of the Committee were to be followed then that would necessitate precise guidance on what constitutes ‘purely commercial’, and how

such transactions would be identified.

The Committee’s suggestion to introduce a monetary threshold for granting exemption from section 124(5)(xiv), is certainly welcome, as it would eliminate

unwarranted burden that may have arisen on small and economically insignificant transactions.


(DTC)




Committee of Finance (the Committee of SCF)

A. Determination of Arm’s Length Price

• The price at which the international

transaction has been undertaken shall be

deemed to be the arms length price (ALP)

if the variation between the ALP (i.e.,

price determined by the most appropriate

method, if only one price is determined;

or arithmetic mean of prices if more than

one price is determined) and the price at

which the international transaction has

been undertaken does not exceed 5% of

the latter [Sections 117 (4) and 117 (5) of

the DTC]


• A range concept, instead of arithmetic mean,

should be introduced to provide more sanctity to

the comparison being made.

MoF response

• The arithmetic mean concept is simple to

understand and easy to administer. The Central

Government would modify the DTC to incorporate

the percentage of variation for different kinds of

transactions.

No response

PwC News Alert

March 2012


19


(DTC)





B. Most Appropriate Method

• ‘The arm’s length price in relation to an

international transaction shall be

determined in accordance with any of the

methods as may be prescribed, being the

most appropriate method.’


• The following methods should be specified in

section 117(1):

- comparable uncontrolled price method (CUP);

- resale price method (RPM);

- cost plus method (CPM);

- profit split method (PSM);

- transactional net margin method (TNMM);

- such other method as may be prescribed by the

Board

• It is proposed that CPM should be strictly followed

in majority of the transfer pricing (TP) assessment

proceedings, for the following reasons:

• information regarding elements of cost are

available from books of account

• this is not based on subjective judgement

• fair determination of cost is possible

• being the most reliable method.

MoF response

• It would be inappropriate to provide that CPM be

used in majority of the TP cases. Cost is not the

only aspect of a transaction. The most appropriate

method as mandated by the statute should be used,

and its selection should be based on the nature of

the international transaction, availability of data

and the functional and risk profile of the taxpayer.

No response

PwC News Alert

March 2012


20


(DTC)





PwC’s Comments

The MoF has simply reiterated the statute with respect to selection and application of the most appropriate method, and has also reaffirmed the position that there is

no prescribed priority of methods.


(DTC)





Advance Pricing Agreement (APA)

Section 118 of the DTC deals with provisions

relating to Advance Pricing Agreement (APA).

Key provisions are as below

• The CBDT with the approval of the

Central Government may enter into an

APA with any person, specifying the

manner in which ALP is to be determined

in relation to an international transaction,

to be entered into by that person.

• The APA binds the taxpayer as well as the

department in relation to only that

particular transaction which is covered

under the APA, the validity of which is up

to a maximum period of 5 years. The APA

shall not be binding in case of an

amendment to the DTC.

• The CBDT, may, by notification, frame a

scheme for APAs.

[Section 118]


• Safeguards should be put in place to ensure that a

corresponding adjustment is allowed in the books

of the other transacting AE.

• Framing APAs should be entrusted to an

independent agency appointed by the CBDT.

• A mechanism should be formulated by which the

taxpayer may apply for a review of an APA.

• Time limit for finalising the APA should be

prescribed to avoid undue delay in finalizing the

APA.

• A procedure to enable withdrawal of an application

for APA should be provided.

• There should be provisions for renewal of the APA

after the expiry of 5 years, in case the business

model of the taxpayer remains the same;

• It should be provided that an APA should be

valid/binding on the successor of the business,

subject to the successor opting for the same.

• If the APA is not accepted by the tax authorities of

• Mechanism for framing APAs should be entrusted to

an independent agency appointed by the CBDT.

• Independent agency should consist of technical and

judicial members to ensure that the APAs reflect the

prevalent commercial practices/ realities.

• Procedural safeguards to fortify the interest of

applicants should be put in place.

• APAs should be concluded in a time-bound manner.

• Tax treaties, already concluded, should be suitably

amended to include APAs and in future, the APAs

should be included in the tax treaties.

• The existing Advance Ruling System should also be

expanded to cover the resident entities.

PwC News Alert

March 2012


21


(DTC)






the other country, a mechanism should be in place

for the applicant to review the APA based on the

consideration of the tax authorities of the other

country.

MoF response

• Domestic law cannot force foreign governments to

provide corresponding adjustments. Conflicting

interests of two jurisdictions can be addressed only

through bilateral APAs under tax treaties.

• Issues raised as regards review would be examined

at the time of framing of the scheme by the CBDT.

PwC’s Comments

• Whilst the concept of having an independent agency for framing the APA mechanism is welcome, it may be worthwhile to also consider having industry

representatives/specialists as part of the agency panel to ensure that the APA program meets its objectives. The combined acumen of technical, judicial and

industry experts will also truly help in reflecting the prevalent commercial practices/ realities as suggested by the Committee.

• The Committee has suggested incorporation of procedural safeguards to protect the applicants’ interests. Although not specified, however, this could

optimistically be read to include provisions relating to maintenance of confidentiality, i.e., prevention of use of one taxpayer’s information against another;

provisions relating to immunity from retroactive amendments in law; provisions which allow a one-time transfer pricing adjustment (once the APA is concluded

- for the differential price, and covering the period during which the APA was being negotiated) without application of interest /penalty/ withholding related

provisions; etc.

• Such procedural safeguards, if introduced, will render significant credibility to the APA program and build trust and confidence, amongst taxpayers, in the APA

process.

• Whilst it is ideal to have a time bound plan for completion of an APA process, however based on practical experience, bilateral or multilateral APAs typically take

a longer time to settle, owing to the number of tax jurisdictions involved. The unilateral APA process, on the other hand, is known to take approximately a year in

jurisdictions having developed and mature APA programs. Hence a time bound APA process may be more appropriate in the case unilateral APAs.

• In spite of representations from several stakeholders, neither the MoF nor the Committee has made any comments relating to provisions for roll-back of APAs;

PwC News Alert

March 2012


22


(DTC)






withdrawal of APA applications; acceptable levels of changes in critical assumptions (such that every small change does not lead to re-negotiation or cancellation

of an APA); renewal and review of APAs, etc. Such provisions would go a long way to ensure effective implementation of the APA program in India.

• The Committee has suggested that tax treaties be amended to include APAs. This is, however, not clear, because once there are APA related provisions in the

domestic law, unilateral APAs would get implemented there under, while bilateral APAs would anyways be executed under the tax treaties (under the Mutual

Agreement Procedure).

Our Offices

For private circulation only

Ahmedabad

President Plaza, 1st Floor Plot No 36

Opp Muktidham Derasar

Thaltej Cross Road, SG Highway

Ahmedabad, Gujarat 380054

Phone +91-79 3091 7000

Bangalore

6th Floor, Millenia Tower 'D'

1 & 2, Murphy Road, Ulsoor,

Bangalore 560 008

Phone +91-80 4079 7000

Bhubaneswar

IDCOL House, Sardar Patel Bhawan

Block III, Ground Floor, Unit 2

Bhubaneswar 751009

Phone +91-674 253 2279 / 2296

Chennai

PwC Center, 2nd Floor

32, Khader Nawaz Khan Road

Nungambakkam

Chennai 600 006

Phone +91-44 4228 5000

Hyderabad

#8-2-293/82/A/113A Road no. 36,

Jubilee Hills, Hyderabad 500 034,

Andhra Pradesh

Phone +91-40 6624 6600

Kolkata

South City Pinnacle, 4th Floor,

Plot – XI/1, Block EP, Sector V

Salt Lake Electronic Complex

Bidhan Nagar

Kolkata 700 091

Phone +91-33 4404 6000 / 44048225

Mumbai

PwC House, Plot No. 18A,

Guru Nanak Road - (Station Road),

Bandra (West), Mumbai - 400 050

Phone +91-22 6689 1000

Gurgaon

Building No. 10, Tower - C

17th & 18th Floor,

DLF Cyber City, Gurgaon

Haryana -122002

Phone : +91-124 330 6000

Pune

GF-02, Tower C,

Panchshil Tech Park,

Don Bosco School Road,

Yerwada, Pune - 411 006

Phone +91-20 4100 4444

For more information contact us at,

[email protected]

The above information is a summary of recent developments and is not intended to be advice on any particular matter. PricewaterhouseCoopers expressly disclaims liability to any person in respect of anything done in reliance

of the contents of these publications. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of PricewaterhouseCoopers, this Alert may not be quoted in

whole or in part or otherwise referred to in any documents

©2012 PricewaterhouseCoopers. All rights reserved. "PwC", a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of

PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.

m/in sharing insights dtc 2009 proposed to replace the income-tax act, ... • the dtc should...

Documents