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Budget 2018 Analyzing Tax Proposals

The article takes a close look at the highlights of Union Budget 2018 in terms of direct and indirect taxes

While Budget proposals of 2018 were in all aspects people-friendly with announcements on major reforms in healthcare, agriculture, air pollution, job creation, roads and railways and other common problems of the common man, the direct tax and indirect tax proposals were also landmarks on their own account. 2018 being the first budget after introduction of GST, a few changes are proposed on Indirect taxes front. The nomenclature of central indirect tax regulatory body has been proposed to be changed to demonstrate the subsuming of excise duty on major goods within GST ambit.

Accordingly, existing name is proposed to be changed from Central Board of Excise & Customs (‘CBEC’) to Central Board of Indirect Tax & Customs (‘CBIC’). Education cess and Secondary and Higher Education cess has been proposed to be abolished on imported goods. A new cess namely ‘social welfare surcharge’ shall be introduced (not to be included while computing Integrated GST). Other significant proposal is the levy of ‘road and infrastructure cess’ of INR 8 per litre (from existing INR 6 per litre) on petrol and diesel, as an additional excise duty on imported goods. This is coupled with reduction of basic excise duty on both fuels by INR 2 per litre. Accordingly, the combined effect on consumers is nullified. The rationale behind this change seems to provide for the shortfall in government coffers post GST roll-out since a cess is entirely governed by Central government while basic excise duty is a shared subject between State and Centre with States entitled to more than 40 per cent of tax collections. Besides this, Basic customs duty has been enhanced to almost in an array of imported products making branded and luxury commodities expensive. A surprising entry to this list is the food processing category wherein BCD has been increased on import of fruit juices and other food preparations from 30 per cent to 50 per cent. This seems to create tariff barriers for imported goods in order to promote in-house domestic manufacturing of processed food in India.

From direct tax perspective, Income Computation Disclosure Standards (‘ICDS’) were given a fresh lease of life, after the recent taxpayer favorable Delhi High Court decision¹ that rendered those ICDS unconstitutional, which overruled binding judicial precedents. Finally, budget proposals were introduced to render constitutional validity to ICDS through the introduction of six out of ten ICDS as part of the Income Tax Act, namely ICDS II (Inventory valuation), III (Construction contracts), IV (revenue recognition), VI (Forex fluctuations), VII (Government grants) and VIII (securities).

The change in section 36 (1) and 40A allows for market to market losses arising from monetary items. This change is in line with the Supreme Court ruling in case of CIT vs Woodward Governor (312 ITR 254). On the other hand, many landmark Apex Court decisions stand overruled due to the specific introduction of guidance provided in ICDS as part of Income tax statute. For instance: losses arising on forward exchange contracts in case of currency derivatives held for trading or speculation purposes or hedging foreign currency risk shall not be allowed while computing taxable income. This tax position is diametrically opposite to the ratio decided by Supreme Court in case of Sutlej Cotton Mills vs CIT² which held that foreign exchange loss incurred on account of trading liability would be a deductible expenditure.

Besides the above, there are certain differences between the proposed sections (based on ICDS) in Income tax Act in comparison to the ICDS notified in September 2016. Such anomalies should be creased out in the final section at the time of approval of the Finance Bill. One of such differences is the contrast that emerges out of proposed definition of ‘securities’ as defined in section 145A (iii) in comparison with para 3(1)(b) of ICDS VIII. Whereas the tax standard defines securities as defined under Securities Contracts (Regulations) Act, 1956, the definition used in the proposed section states that securities listed but not regularly quoted on a recognized stock exchange shall be covered. Accordingly, one may infer that the bucket approach of valuation shall not apply on regularly traded listed securities.

No horizontal corporate tax rate change was announced except for small and medium sized companies as defined in the Budget proposal. The corporate tax rate was reduced to 25 per cent for companies having aggregate turnover/ gross receipts not exceeding INR 250 crore. This was an extension of benefit bestowed on small and medium sized companies in last budget, wherein a reduced corporate tax rate benefit of 25 percent was passed to companies having less than INR 50 crore of business turnover. Further, with no change in surcharge rate, the existing Education Cess at 2 percent and Secondary and Higher Education Cess at 1 percent is proposed to be abolished. In its place, a new ‘Health and Education Cess’ is proposed to be introduced at the rate of 4 percent on Income Tax plus surcharge (as applicable).

Another landmark budget proposal was the re-introduction of long term capital gains tax in the taxing statute. The current exemption from long term capital gains (LTCG) tax was introduced in 2004 with introduction of Securities Transaction Tax (STT). After 14 years, exemption from LTCG is proposed to be removed with proposal for removal of section 10(38) and insertion of a new section 112A to tax such LTCG.

Concessional LTCG tax of 10 per cent has been proposed, arising from transfer of an equity share, or a unit of an equity-oriented fund or a unit of a business trust where STT is paid both at the time of purchase and sale. In certain cases, STT is not paid initially at the time of purchase of shares viz. in case of bonus shares, sweat equity shares etc. There is no clarity yet as to the rate of LTCG that shall apply to such situations where STT is not paid at the time of purchase. Further, STT on capital gains was introduced with a view to simplify taxing such through imposing tax on securities turnover. Whilst the proposal for imposing LTCG tax at 10 per cent is made, no indication of removal of STT is yet made. Imposing both taxes on a share transaction is burdensome for taxpayers. Also, suitable amendments are not made in section 48 resulting in indexation benefit being still available for computing LTCG. Accordingly, does the taxpayer need to compute LTCG in accordance with both section 112A (without indexation) and section 48 (with indexation) and should derive at the beneficial result for the purpose of imposing the LTCG rate of tax, is still to be clarified.

Such long term capital gains tax shall be levied on gains in excess of INR one lac. It needs to be clarified whether the exemption of 1 lac rupees is available as a standard deduction or whether the entire long term capital gains shall be taxable if the total long term gain exceeds one lac. No indexation benefit shall be provided. The proposals shall take effect from April 01, 2018 with grandfathering provisions being available for shares purchased prior to January 31, 2018 and sold after March 31, 2018. CBDT has provided clarity on various aspects of the proposed provisions including clarity on long term capital gains computation, applicability of grandfathering provisions on Foreign Institutional investors (FIIs) and withholding tax implications in hands of residents, non-residents including FIIs³. Transfers made between February 01, 2018 and March 31, 2018 will be eligible for capital gains tax exemption under section 10(38) since the new tax regime shall be applicable to transfers made on or after April 01, 2018. Further, no withholding tax provisions shall be applicable on payments of long term capital gains made to FIIs in view of section 196D of the Act. Accordingly, FIIs need to deposit advance tax on their own assessment of long-term capital gains taxes and file tax return in India.

Another vexed issue touched upon in the Budget pertained to regulating cryptocurrency in India. It has been clarified by Finance Minister that Cryptocurrency is not legal tender and government shall discourage its use. In the same breath, a mention was made by FM that government shall look into the aspect of utilization of blockchain technology. Similar announcements were made earlier also by government stating that cryptocurrencies were not legal tenders and several red flags were raised to abstain investors from investing in the aforesaid currencies. Alongside, there were reports around no registrations being granted to companies intending to act as exchange portals for blockchain currencies. With little clarity yet available on the actual classification of cryptocurrencies, the announcement from government to study its utilization and efficacy is a welcome move.

On international tax front, few amendments are proposed viz. amendments to section 9 and changes in Country by Country Reporting (CbCR) provisions.

No significant changes proposed on transfer pricing law except for a few clarifications on CbCR. There has been a proposal of extension of time allowed for furnishing CbCR to twelve months from the end of the reporting accounting year. This announcement aims at aligning Indian transfer pricing regulations with the Organization for Economic Cooperation and Development (OECD).

Further, the due date for furnishing of the CbCR by the Constituent Entity in India that has an overseas parent entity, is proposed to be aligned with the stipulated reporting year of the parent company for accounting purposes. The due date for furnishing the CbCR by Alternate Reporting Entity (ARE) is also proposed to be aligned with its local jurisdiction timelines in a similar manner.

In yet another blow at countering digital economy and cross border e-commerce activity, after equalization levy, India has made another important landmark announcement in the international tax domain by introducing concept of ‘significant economic presence’ in the tax statute through linking it with the definition of business connection under section 9 of the Income Tax Act. Once business connection is established, the income earned in India by a foreign company is subject to corporate tax in India on net basis. The newly proposed concept of significant economic presence includes within its domain all types of transactions, whether pertaining to goods, services, systematic and continuous soliciting of business activities or engaging in interaction with a prescribed number of users in India through digital means. The essential word here is ‘digital means’, irrespective of a physical presence or place of business in India. However, the budget proposal aims at providing a threshold for attracting significant economic presence, which is yet to be prescribed.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.