Significant Proposals in Relation to Non-Residents

1. Global Context and Multilateral Developments

Recently, Organisation for Economic Co-operation and Development (OECD) has proposed Multilateral Instrument (MLI) to bring out the change in tax treaties in efficient and quick manner. It has been signed by more than 90 countries. In addition to change in tax treaties countries are making change in domestic taxation as well to fulfill the gap between existing international taxation system and new forms of business to enable the countries to have their fair share of taxes. At the same time, there is competition among nations to attract foreign investment at maximum for development and growth of economy. Thus, where existing international tax principles are required to be strengthened on one hand, there should be policies to provide friendly and stable business environment on the other. India has recognised this need of the hour as is evident from the Budget 2020 presented by Hon’ble Finance Minister in the Parliament on 1st February 2020.

2. Detailed Analysis of the 13 Significant Non-Resident Proposals

1. Safe Harbor Rules and Advance Pricing Agreement for Determination of Attribution of Profit to Business

Budget 2020 has made amendment to Section 92CB and Section 92CC of the Act to provide for determination of income attributable to business connection/permanent establishment (PE) through Safe harbor rules and advance pricing agreement, respectively.

Attribution of income has always been a litigative area lacking uniformity primarily due to Rule 10. Rule 10 grants wide and open powers to Assessing Officer to allocate income as it deems fit or considerable reasonable. The framing of Rule 10 has led to attribution profit in ad hoc manner by various Appellate Authorities and thereby creates uncertainty in the minds of foreign investors. Availability of Safe Harbor Rules (SHR) would surely provide certainty, subject to the approach that would be prescribed under safe harbor rules. Further, under Advance Pricing Agreement (APA) mechanism, allocation of income may be made through methods prescribed for determination of arm length price (ALP) under section 92C of the Act or method(s) as may be prescribed via supporting Rules.

2. Inclusion of Income from Advertisement and Sale of Data under Income Attributable to Business Connection in India

Taxing Digital economy is one of the top concern worldwide and countries are coming up with different forms of taxes to get their share of tax. Focus has shifted from physical presence or value addition for taxing nexus to market presence over time because of the way technology is used in generating revenue. Though, OECD is working towards achieving consensus of nations to develop a common tax to tax digitalised world, countries have started adopting unilateral measures to protect their tax base. In same lines, India has also proposed to amend the source Rule by inserting Explanation 3A to Section 9 of the Act:

Clause (i), clause (ii) and clause (iii) aims to tax the specified income earned by non residents who have PE in India, in addition to income that was attributable in pre budget provision. In pre budget provision, income arising from functions performed, assets utilised in India are only attributed to PE. It is now proposed to attribute revenue arising from following activities also to PE whether performed in or outside India:

• from sale of advertisement to customer residing in India or customers using internet protocol located in India
• from sale of data collected from a person who resides in India or uses internet protocol address located in India
• from sale of goods and services using data collected as above.

This amendment aims to tax the revenue earned by non-resident through digital marketing, sale of data collected from India and also revenue from consequent sale of goods and services using such data. However, such business does not constitute PE under existing definition in DTAA in the absence of any physical activity/form in India. Thus, proposed provision would not be of much effect unless definition of PE is amended in tax treaties.

Be as it may, non-residents having modest physical presence like the ones acting as market support service provider or warehouse in India, would be affected and proposal may lead to increase in tax base of such non-residents. Since, many tax treaties of India would be modified from 1st April 2020 because India has signed and ratified the MLI. This would have effect of lowering down of threshold of PE and change in application of preparatory and auxiliary exemption. Combined effect of MLI and proposed provision by Finance Bill would bring the revenue from sale by non-resident also under the net, who claimed to have minimal functions in India as of now and compensated on cost plus model.

3. Amendment in Section 94B: Thin Capitalisation Relief for PE of Foreign Banks

Finance Act, 2017 has introduced Section 94B in the Act that provides for disallowance of interest paid by Indian company in excess of 30% of Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA), if loan is availed from non-resident associated enterprise, in computation of taxable income of such Company. Budget 2020 has proposed an amendment to the Section through insertion of sub-section (1A).

Section 92A of the Act defines associated enterprise and as per one of the conditions given under section 92A(2) of the Act, when loan granted by one enterprise constitutes 50% or more of total assets of other enterprise, both the entities qualifies as associated enterprises. Further definition of enterprise includes Permanent Establishment under section 92F of the Act. Thus if branch of any foreign bank has granted loan in excess of 50% of book value of asset, it would constitute associated enterprise under section 92A. This would trigger Section 94B and interest paid by Company on loan taken from such branch would be disallowed in excess of 30% of EBITDA of the Company. Insertion of Section (1A) aims to exclude interest paid in respect of a debt issued by a permanent establishment of a non-resident in India and engaged in business of banking and insurance.

It is a welcome move to bring the foreign banks operating as subsidiary or as a branch at equal footing. Earlier, loan availed from subsidiary of foreign branch would not have attracted Section 94B of the Act while loan availed from branch of foreign bank may be disallowed. With proposed amendment, branch of foreign banks/NBFC would have major relaxation.

4. Amendment in Dispute Resolution Panel (DRP) under Section 144C

Clause 70 of the Finance Bill seeks to amend Section 144C of the Act relating to reference to dispute resolution panel (DRP). Currently, objection can be filed before DRP if there is variation in the returned income or loss of the taxpayer under Draft order issued by the Assessing officer (AO). It has now been proposed to make DRP route available to taxpayers even in cases where there is no variation in returned income/loss but otherwise prejudicial to the interest of the taxpayer. For example change in tax rate of taxpayer, tax credit.

Further, specified taxpayers are only allowed to file objection before DRP in current provision. The specified taxpayers are Foreign Company and any person in whose case transfer pricing adjustment have been made. Non-resident other than company like partnership firm, LLP, etc. were not eligible to adopt DRP route if adjustment is other than for transfer pricing issues. Now, it has now been proposed to include all non-residents under the ambit of specified taxpayer. It is applicable from 1st April 2020 and thus any adjustment made in the hands of any non-resident after such date can now be challenged before DRP. AO would therefore issue the draft assessment order first for adjustment made in the hands of non-resident prejudicial to its interest.

5. Aligning Purpose of Entering into DTAA with Multilateral Instrument (MLI)

MLI is an instrument designed by OECD with G20 nations to enable modification in tax treaties under the project to tackle base erosion and profit shifting (BEPS). India is also signatory to MLI and changes proposed under it are applicable on many tax treaties with India w.e.f April 1, 2020. One of the change proposed by MLI is to modify the preamble of tax treaties that define the scope and purpose of it. Currently, preamble does not prescribe prevention of non double taxation or tax evasion or treaty shopping as the purpose of entering into tax treaty. Purpose of all treaties is either prevention of fiscal evasion, double taxation or promotion of trade and investment. Supreme Court has also upheld in past that when prevention of treaty shopping is not defined as specific purpose, benefit of treaty cannot be denied if transaction is otherwise satisfying the purpose of treaty even if it is for tax evasion or treaty shopping.

Article 6 of MLI would modify the Preamble of tax treaties now as:

Under the existing Act, Section 90 empowers Central Government to enter into tax treaty with following purpose: (i) Granting tax credit in case of double taxation, (ii) Avoidance of double taxation, (iii) Exchange of information, (iv) Recovery of tax.

Since avoidance of non-taxation, fiscal evasion or treaty shopping are not listed in Section 90 of the Act, it may create legal challenge to amend tax treaties outside the scope of Section 90 and therefore it has been proposed to amend clause (b) of sub-section (1) of Section 90 of the Income Tax Act so as to provide that the Central Government may enter into an agreement with the Government of any country outside India or specified territory outside India for, inter alia, the avoidance of double taxation of income under the Act and under the corresponding law in force in that country or specified territory, as the case may be, without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of any other country or territory).

Similar amendment has been proposed in Section 90A of the Act that empowers specified association in India to enter into an agreement with any specified association in the specified territory outside India after adoption by Central Government.

6. Exemption for Sovereign Wealth Funds & Abu Dhabi Investment Authority under Section 10(23FE)

One of the most significant proposals in Budget 2020 to boost infrastructure sector in India is exempting income earned by Sovereign Wealth Funds in India including Abu Dhabi Investment Authority (ADIA). A new Section 10(23FE) has been introduced which will exempt income of SWF in the nature of dividend, interest or long term capital gains arising from an investment made in India on or before 31st March 2024.

Such exemption would be available if the investment is made in infrastructure companies or enterprises and investment is held for a minimum period of three years. India requires enormous money for all round infrastructural growth; this 100% tax exemption by India is expected to make India a darling country for investment within SWFs.

7. Modification in Conditions for Offshore Funds’ Exemption from “Business Connection” under Section 9A

Another modification which has been proposed to boost investments in India is relaxing conditions to qualify as business connection under section 9A of the Act. Section 9A of the Act is like a safe harbour provisions whereby an “eligible investment fund” is not regarded as having a “business connection” in India merely because an “eligible fund manager” undertaking fund management activities on its behalf is located in India until certain conditions listed in the said Section are satisfied.

Currently Offshore Funds are allowed to invest only up to 5% of the total fund corpus; now via Budget 2020, it has been proposed to allow Offshore Funds upto Rs. 25 crore over three years from the start of the fund without 5% barrier. Another proposal, which is more in the nature of rationalisation, is if the fund has been established or incorporated in the previous year, the condition of monthly average of the corpus of the fund to be at Rs. 100 crore shall be fulfilled within twelve months from the last day of the month of its establishment or incorporation.

8. Exempting Non-Residents from Filing Income-Tax Returns in Certain Conditions (Section 115A)

Currently, Section 115A of the Act exempts non-residents from filing annual income-tax return, if the total income comprises only of dividend or interest, and TDS on such income has been deducted as required under Chapter XVII–B of the Income-tax Act, 1961. Now, it has been proposed to extend this benefit to those taxpayers whose income comprises only of royalty or fees for technical services (FTS).

Above proposal is a welcome move from the CBDT; however, the above benefit comes with a rider that the tax should have been deducted as per the provisions of Section 115A. Apparently, it seems wherein TDS is deducted at a lower rate (or nil) because of treaty benefit, in comparison to rate prescribed under section 115A, non-resident would be required to file Annual Income Tax Return in India, even if its income only comprises of Royalty and FTS.

9. Modification of Residency Provisions under Section 6

Reducing Short Exemption Stay Threshold

On many occasions it has been found that non-resident Indians visit India, stay here for good amount of period and manages their economic activity from India without paying taxes on their global income. In order to check such abuse of beneficial provision given in clause (b) of Explanation 1 of Section 6 of the Act, it has been proposed to decrease the period of 182 days to 120 days. As a result, wherein Indian citizen or person of Indian origin, who is also a non-resident, comes on a visit to India for more than 120 days, he would now become Resident starting April 2020.

Taxing Stateless Residents: Section 6(1A)

In addition to above, another anti-abusive amendment proposed in Budget 2020 is to tax such Indian citizens who are not tax residents of any country. As per Memorandum explaining the finance bill, there are certain individuals, typically high net worth individuals, who arrange their affairs in such a way that they do not become liable to tax in any Country. In order to catch such individuals, a new sub-section (1A) has been added in Section 6 of the Act, according to which an Indian citizen who is not liable to tax in any other country or territory shall be deemed to be resident in India.

However, framing of provision created concern among genuine taxpayers who are based out in country with no taxes like UAE. To clarify, Government issued a press release stating:

Relaxing Conditions for “Not Ordinarily Resident” (RNOR)

Currently, the Act lays two conditions to qualify as “Not Ordinary Resident”: (a) Person is Non-Resident in any 9 out of 10 preceding financial years, and (b) The aggregate stay in India during 7 preceding financial years is 729 days or less. Keeping in mind the two amendments in Section 6 of the Act, because of which certain individuals may qualify as residents, it seems in order to avoid hardship the condition to qualify as “Not Ordinary Resident” has been relaxed.

10. Removing DDT and Transitioning to Classical Dividend Taxation

Budget 2020 has proposed that the provisions of Section 115-O shall not be applicable on dividends distributed after 31st March 2020 (FY 2020-21 onwards). Domestic companies are not required to pay DDT; instead dividend will become taxable in the hands of the shareholder. This shifting of taxability creates a beneficial scenario for non-resident shareholders.

In most tax treaties entered by India, the source country (India) is allowed to tax dividend at rates within the range of 5% to 15%. So now wherein a non-resident is able to claim treaty benefit, the effective tax rate would drop from 20.35% to 5%–15%. There is, however, modification in tax treaties in respect of conditions to make beneficial rates available to receiver of dividend through MLI – Article 8. This interplay of MLI with domestic provisions needs to be analysed for determining final taxability.

11. Deferral of Significant Economic Presence (SEP)

Finance Act, 2018 inserted Explanation 2A to Section 9(1)(i) to clarify that Significant Economic Presence (SEP) of a Non-Resident in India constitutes a “business connection”. However, since discussions are ongoing in the G20-OECD BEPS project and the consensus report is expected by December 2020, Finance Bill 2020 has proposed to defer the applicability of SEP to Assessment Year starting 2022-23.

12. Advance Due Date for Filing Form No. 3CEB

It has been proposed to advance the due date for filing Form 3CEB from November 30th to October 31st. Thus for financial year 2019-20, the due date of filing Form No. 3CEB is proposed to be 31st October 2020. This amendment is primarily proposed to enable pre-filing of income tax returns and synchronize accountant transfer pricing reports with tax audit reports.

13. Levy of Withholding Taxes on e-Commerce Transactions (Section 194-O)

Section 194-O of the Act is proposed to be inserted to levy withholding tax on e-commerce transactions w.e.f. April 1, 2020 @ 1%. It would be levied on sale of goods or services by e-commerce participants using e-commerce platforms operated, owned or managed by e-commerce operators. Apparently, this Section would also be applicable on non-resident e-commerce operators.