Budget 2025 Expectations: Direct Tax

Rohinton Sidhwa, Partner, Deloitte India

Current direct tax policy landscape

In recent years, the government has undertaken several commendable initiatives to reform the direct tax landscape in India. Key measures include:

• Reduction in corporate tax rates: A strategic move to attract investments and improve India’s global competitiveness.
• Rationalisation of withholding tax rates: Simplified compliance for businesses while ensuring efficient revenue collection.
• Stabilisation of capital gains taxation: Enhanced clarity and predictability, fostering greater confidence among investors.
• Resolution of legacy tax disputes: Initiatives such as the Vivad se Vishwas scheme have successfully reduced litigation, enabling quicker dispute resolution and freeing resources to focus on contemporary tax matters.

While these reforms have strengthened the foundation of the tax system, there remain opportunities for further refinement to promote ease of doing business and achieve greater administrative efficiency.

Asks

Extending the reduction of headline corporate tax rates for new manufacturing companies and Global Capability Centres (GCC)

• The existing concessional corporate tax rate, set at 15 percent, has been pivotal in attracting investments into India. This rate is currently available to new domestic manufacturing companies under Section 115BAB. However, one of the prerequisites to avail this benefit was that the companies were to commence manufacturing operations by 31 March 2024.
• Considering the significant role this measure has played in promoting economic goals and attracting foreign investments, the tax policy administration may think about reintroducing this regime for companies starting manufacturing operations from 1 April 2024.
• Extending the concessional tax rate would provide an opportunity for such investors who are currently in the process of setting up or considering India as a potential investment destination to use this opportunity.
• There has been progressive growth of GCCs (entities providing support to parent or group entities) in India over the past 5 years. The number of GCCs in India has risen to 1700, with an estimated revenue of about US$64.6 million, which is expected to reach around 2100–2200 by 2030. Considering the growth potential both in terms of revenue and job creation, a similar benefit of a lower rate of 15 percent may be extended to GCCs.

Clarity on transactions involving the transfer of shares

Provide clarity on taxation of contingent consideration on the sale of shares

• There are instances when share transfer arrangements include clauses for payment of sale consideration in tranches, with one at the time of consummating the transaction and the remaining on the satisfaction of conditions in the future year. Accordingly, the transferor shareholder does not have clarity on the quantum of future receipt at the time of sale.
• There is no clarity on whether the contingent consideration is taxable in the year of transfer of the shares or the year in which the conditions are satisfied in future years.
• In line with the provisions relating to taxation of compensation received on compulsory acquisition of assets, a clarification can be introduced to tax contingent consideration in the year in which the consideration is received.

Exemption from levy of capital gains in indirect transfers within the group

• Internationally (such as in the UK and Australia), it is an accepted principle that business reorganisations within a group are tax-neutral, subject to conditions.
• In the absence of specific exclusion, such as the one prescribed under section 47 of the Act, capital gains arising on intra-group transfer of shares of a foreign company having underlying assets in India will be taxable.
• As the business reorganisation within a group does not result in any real income, such transfer, whether in India or outside, should be tax neutral, subject to sufficient safeguards to prevent misuse of such exemption by way of continuity of ownership.
• Hence, a specific provision may be introduced to exempt transactions within the group from the application of indirect transfer provisions in the hands of the shareholder of the foreign company undertaking reorganisation.

Rationalisation of withholding tax rates

• Currently, there are various rates at which taxes are to be deducted/collected at source, ranging from 0.1 percent to 10 percent. These have often led to litigations arising out of the ambiguities across multiple provisions.
• The government can consider rationalising the rates under the following four broad categories.
  • First category: Transactions involving the purchase of tangible/material goods—TDS @ 1 percent, without any threshold limit
  • Second category: Transactions involving the supply of any type of services—TDS @ 2 percent, without any threshold limit
  • Third category: Transactions through electronic medium/platform—TDS @ 0.1 percent
  • Fourth category: Residuary transactions such as interest and dividend—TDS @ 10 percent
     

International Tax: Relaxation of compliance for claiming treaty benefit and clarity on applicability of Significant Economic Presence (SEP)

Relaxation in the filing of Form 10F for claiming treaty benefits

• Currently, non-resident taxpayers are required to electronically file Form 10F on the e-Filing portal to avail any treaty benefits.
• Along with Form 10F, non-resident taxpayers are required to provide a copy of the Tax Residency Certificate (TRC) from overseas tax authorities for the entire financial year to confirm their residency status in the other country.
• No overseas tax authorities provide a TRC certifying that the taxpayer is a tax resident for the future period.
• Hence, suitable amendments can be made along with Form 10F, where the taxpayer can furnish TRCs from the previous period (say, for the last 1–2 years) and a copy of the TRC for the current financial year may be provided later (say at the time of filing of its tax return in India).

Disclosures on the applicability of Significant Economic Presence (SEP) in Income Tax Return (ITR)

• A non-resident is considered to have a SEP and shall constitute a business connection in India if either of the conditions are satisfied:
• - Aggregate of payments arising from transactions in respect of any goods/services or property in India by a non-resident exceeding INR2 crore or
  - Non-resident engaged in soliciting its business activities or dealing with 3 lakh or more users in India through digital means.

• Non-residents filing tax returns in India must disclose if they havea SEP in the country.
• However, a non-resident can avail benefits available under the tax treaty per which its business income is taxable only if it has a Permanent Establishment (PE) in India.
• It is unclear whether such a non-resident is required to disclose SEP with or without considering the existence of a PE in India.
• Hence, a suitable clarification may be issued on scenarios as to when a non-resident is required to disclose whether or not it has a SEP in India.

Incentivising innovation

Extending tax benefits beyond patents and residents

• Investing in Research & Development (R&D) is crucial for advancing manufacturing processes and technologies. These advancements can spur innovation and strengthen the manufacturing sector's capabilities.
• Substantial investment in R&D, both in strengthening existing institutions and establishing new research institutions, is essential to reduce reliance on foreign technology and innovations.
• Under the extant patent box regime, royalty income arising from patents registered by Indian residents under the Patent Act shall be subject to a lower tax rate of 10 percent, subject to 75 percent of expenditure/the development being undertaken in India.
  The current patent box regime has a limited scope; it does not cover other Intellectual Property (IP), such as know-how, copyrights, designs and trademarks (for various countries, including Ireland and China). Additionally, it does not extend concessions to subsequent owners (transferees) of the patent (such as Ireland and Netherlands) and is not restricted to the first inventor of the invention, as in the extant law.
• The government may consider extending the patent box regime:

o The current regime is applicable only to Indian residents. Measures can be taken to extend the regime to non-residents as well, with some checks, such as carrying out substantial development of IP in India;

o Expanding the scope of the term “patentee” so that the concessions are available to the subsequent owner (transferee) of the patent, subject to conditions to prevent misuse;

o Current regime benefits can be extended to income from designs, copyrights, models and process innovations, similar to the incentives extended by countries such as China, Ireland and Luxembourg.

o Currently, no expenditure is allowed against income. Certain R&D expenses, amortisation of intangibles and other charges may be allowed as a deduction and the resultant net income can be taxed at a lower rate. Likewise, losses incurred during R&D efforts can be allowed to be carried forward and set off in future years against royalty income.

Production Linked Incentives (PLI) for R&D

• With the removal of the weighted average deduction on R&D spends, taxpayers investing in R&D do not have any additional tax incentives on the spends incurred on R&D.
• An incentive could be provided through an additional deduction of certain specified expenditures spent on R&D (salary costs, materials used, etc.) based on the additional turnover generated through R&D spends compared with earlier year turnover and/or additional employment generated by a taxpayer in R&D and/or based on additional investments made in fixed assets specifically for R&D.
• This would incentivise the directing of private investments into R&D.

Policy recommendations
Creation of Task Force (TF)

• Business models are rapidly changing, due to which the nature of tax issues and their corresponding conclusions need an understanding of the industry, failing which results in multiple tax disputes.
• A TF comprising senior revenue officials and industry experts should be established.
• Important tax issues may be referred to the TF, carry out detailed research, invite discussions from stakeholders and advise the Central Board of Direct Taxes (CBDT) on the tax position to be taken.
• Once CBDT approves, the same can be issued as a guidance note by CBDT, and such a guidance note can be put up to taxpayers detailing the tax position of the administration, which would guide taxpayers in not taking any aggressive tax positions and avoid litigation.

Addressing taxation on the buyback of shares

• Buyback has been a commonly adopted exit/repatriation strategy by investors.
• Tax implications on the buyback of shares underwent changes with effect from 1 October 2024 vide amendments introduced by Finance (No.2) Act 2024. Under the amended provisions, consideration received pursuant to a buyback will be treated as dividends and accordingly taxed in the hands of the shareholders as “income from other sources”. Further, the acquisition cost for shares bought back will be considered a capital loss, which can be set off and carried forward against other capital gains.
• In certain scenarios, a shareholder receives consideration equivalent to the capital investment without an upside in value but ends up paying tax on the receipt. This is against the principles of taxation wherein only the income is to be brought to tax and not every receipt. While the shareholder does get the benefit of capital loss, this may or may not be useful to a shareholder.
• In view of the above, it is recommended that the government provide a clarification that on buyback to the extent of capital returned, there should be no tax liability in the hands of the shareholders and, accordingly, no capital loss in the hands of the shareholder.
   

Rationalisation measures for assessments and appeals

Allow protective assessments on issues where taxpayers have succeeded, but revenue authorities contest the issue at higher forums

• Repetitive additions are made in assessments as a revenue appeal for the same issue in an earlier year (which has been held in favour of the taxpayer by the Income Tax Appellate Tribunal (ITAT)) is pending before the High Court (HC)/Supreme Court (SC).
  
• This blocks taxpayer’s working capital flow even though they have succeeded at the ITAT. The tax amount on these repeated additions also adds to the high “disputed demand” statistics of the tax department.
• Hence, any addition made on a disputed issue already ruled in favour of the taxpayer by the ITAT should be made in subsequent assessments on a “protective basis” so that no demand is raised/crystalised on that issue.
   

Power of ITAT to grant a stay of demand

• Currently, ITAT has the power to grant a stay if the taxpayer deposits not less than 20 percent of the tax demand or furnishes security of an equal amount.
• Hence, even in genuine cases or in case of high-pitched adjustments, taxpayers need to remit at least 20 percent of the tax demand.
• Given that ITAT is a quasi-judicial authority, enforcing such a pre-mandate for the grant of stay causes hardship in high-pitched assessments.
• A limit of 20 percent should be done away with; ITAT can provide a stay based on facts of each case considering legal merits and financial position of the taxpayer with an outer limit of 20 percent to be paid.

Release of refunds determined under Order Giving Effect (OGE)

• Currently, Assessing Officers (AOs) are required to pass orders to give effect to orders of the Appellate authorities within stipulated durations based on the nature of the orders passed.
• However, tax refunds determined per the said orders are significantly delayed, considering that the refunds are released by the Centralised Processing Centre (CPC) after a period of 5–6 months from the date of OGEs.
• For the intervening period, i.e., from the date of the OGE until the actual credit of the refund to the bank, the taxpayer does not receive interest on refunds even though the provisions of the Act mandate that interest be calculated until the date on which the refund is credited to the taxpayer’s account.
• The taxpayer, in such case, is required to file a fresh application before the AO seeking additional interest, which is generally not accepted by the AO, citing that there is no mistake in the order passed by the AO.
• The timeline for releasing the refund from the date of the order must be kept within 15 days, failing which taxpayers should be paid interest for delay in crediting the refund determined.

Contributed by: Ananthapadmanabhan S, Partner, Deloitte Haskins & Sells LLP