Direct Tax

Rohinton Sidhwa, Partner

Current direct tax policy landscape

• India is poised for significant economic growth, supported by a politically stable environment amid global uncertainty. This is particularly evident as international investors actively seek to diversify and reconfigure their supply chains.
• India’s current direct tax policy landscape is constantly evolving. It is driven by the government’s efforts to reform existing systems and processes, with a focus on improving efficiency and transparency.
• Significant measures, including a reduction in corporate tax rates, introduction of concessional tax regimes and elimination of the minimum alternate tax regime, have been taken to attract investment and create a favourable business-friendly tax climate.
• The government has started implementing automation measures to enhance transparency and efficiency in tax administration.
• In view of the current government’s return to power, efforts will continue to be made to nurture the Indian manufacturing sector through the ‘Make in India’ campaign and amendments to the policy framework and administration to enhance the ease of doing business in the country. While policymakers focus on harmonising tax rates and incentives to attract investment, tax policy continues to face challenges due to various judicial pronouncements and legislative changes.
• Despite these challenges, India’s current tax environment presents significant opportunities for a more taxpayer-friendly and investment-attractive system.

The tax policy administration can undertake the following six asks to take advantage of this opportunity:

Ask #1: Extending concessional corporate tax rate for new manufacturing companies

• The existing concessional corporate tax rate of 15 percent has been crucial in attracting investments in India. This rate is currently available to new domestic manufacturing companies under Section 115BAB. However, a crucial requirement for these companies is to commence manufacturing operations by 31 March 2024.
• Introduced in 2019, the concessional rate has yielded remarkable results, significantly boosting Foreign Direct Investment (FDI) in the Indian manufacturing sector. To put it in perspective, there was a substantial increase in FDI, from INR89,766 crore in FY 2020–21 to INR1,58,332 crore in FY 2021–22, showcasing a 76 percent surge (source: https://pib.gov.in/PressReleasePage.aspx?PRID=1846088).
• Recognising the substantial role this measure has played in advancing economic objectives and attracting FDI, the tax policy administration may extend the sunset clause of this regime for an additional two years, with effect from 1 April 2024. This extension will undoubtedly contribute to India’s economic growth, enhancing its attractiveness to investors.
• The new import policy, which encourages domestic manufacture of Personal Digital Assistants (PDAs) and restricts imports through its licensing model, has led to tech giants announcing plans for expansion of investment and manufacturing in India. These opportunities can be capitalised further.
• Extending the concessional tax rate would provide an opportunity for investors who are setting up or considering India as a potential investment destination to take advantage of this opportunity.

Ask #2: Implementing settlement scheme to resolve past tax disputes arising from differential treaty interpretations

• Foreign investors have often faced tax disputes due to differences in treaty interpretation. The recent decision by the Supreme Court in the Nestlé SA case has added to this uncertainty. The decision had extensive ramifications for treaty interpretation and various treaty benefits that taxpayers have historically availed. A key takeaway from that ruling is the necessity for specific notifications from the tax policy administration under the Act to implement treaty protocols, especially in the context of the “Most Favoured Nation” (MFN) clause.
• The tax policy administration is expected to release guidelines regarding the interpretation of protocols for treaties between India and various countries. These guidelines will be intended for implementation in future transactions, promoting clarity and consistency in treaty interpretation.
• However, recognising the need to provide certainty and resolution for present cases where a low rate has already been claimed, the tax policy administration should consider establishing guidelines under a settlement scheme. Such schemes could provide a one-time window for taxpayers to make voluntary tax payments of differential taxes without interest or penalty. This initiative would offer relief and certainty to taxpayers, providing an impetus to investor confidence while also facilitating efficient tax collection from the perspective of the tax administration.

Ask #3: Incentivising exports through the tax holiday regime

• The tax policy administration previously granted income tax exemptions to Indian companies engaged in exporting services, leading to substantial growth in the services sector. However, these income tax exemptions are no longer available due to the sunset provision under Sections 10 and 80 of the Income Tax laws.
• Reintroducing a tax holiday or exemption could stimulate exports. This approach would attract foreign exchange and align with the government’s Make in India campaign, encouraging MNCs to establish export hubs in the country.
• To foster exports, the tax policy administration may consider reinstating tax exemptions for income generated from the export of both goods and services. This would revitalise India’s export sector and strengthen its position in the global market.

Ask #4: Promoting R&D through weighted deductions

• Due to the focus on promoting manufacturing, investing in R&D is crucial for developing advanced 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 for reducing reliance on foreign technology and innovations.
• To promote R&D, the government has introduced various policy initiatives, such as the Atal Innovation Mission and R&D policy in the pharma sector. A resurrected tax holiday and reinstated R&D deductions could transform India into a hub for cutting-edge R&D, aligning with global trends and strengthening our manufacturing capabilities.
• By reinstating these tax incentives, India can further foster innovation and position itself as an R&D hub, especially for Global Capability Centres.

Ask #5: Propelling the renewable energy sector through incentives and tax holidays

• Tax incentives in the renewable energy sector is a pre-requisite to accelerating the transition towards sustainable practices. Considering India’s consumption pattern, the call for higher capital expenditure in renewable energy is increasing. PLI schemes, along with corporate tax benefits and ease of funding for infrastructure, manufacture and storage of energy, are imperative to address the challenging requirements.
• With a focus on increasing investment, production and use of electric vehicles, there is a widespread demand from stakeholders to incentivise industries engaged in manufacturing electric vehicles and related infrastructure, such as the installation of charging stations.
• Considering the above factors, the government could consider a 10-year tax holiday for entities engaged in this sector or extend the concessional tax regime provided for manufacturing companies to all entities tending to the renewable energy business. The government may also consider providing investment-linked incentives and/or accelerated depreciation for green energy assets.

Ask #6: Extending the sunset clause for tax on foreign currency interest income

• A concessional 5 percent TDS rate is applicable for interest income on borrowings in foreign currency or to foreign institutional investors or qualified investors up to 1 July 2023. This has provided a viable and attractive avenue for raising funds by Indian businesses, thus helping the country maintain its momentum in economic growth over the years.
• The government may extend the sunset for TDS on foreign currency borrowing by 2–3 years to encourage investments and support the Make in India vision.

Policy recommendations and expected impact/outcome

Recommendation #1: Facilitating corporate restructuring through enhanced tax provisions

• Companies face challenges, such as migration of tax credits, losses, benefits and registrations, during corporate restructuring due to the absence of a comprehensive mechanism/procedure/guideline under the income tax provisions in relation to corporate restructuring.
• Comprehensive guidelines covering various administrative aspects related to corporate restructuring can be formulated to enhance corporate restructuring and minimise litigation faced by taxpayers during restructuring, while also avoiding revenue leakage.
• These corporate restructuring guidelines may be benchmarked against international best practices, ensuring compliance with global standards and promoting India as a favourable destination for corporate restructuring activities.

Recommendation #2: Reducing tax litigation through a policy framework

• In the past, various government initiatives, including amnesty schemes and higher threshold limits for filing appeals, effectively reduced case pendency at tax tribunals, high courts and the Supreme Court.
• After the implementation of the faceless appeal scheme, case pendency at the first appellate stage “CIT(A)” has surged, as recognised in the Finance Act of 2023. Notably, there are no prescribed timelines for the disposal of appeals at this stage. Even during the introduction of the Vivaad se Vishwas scheme in 2020, over 500,000 cases were pending at various fora. Despite the introduction of the Joint Commissioner (Appeals) last year to reduce this bottleneck and clear small disputes, there has been a minor impact on most of the pending appeals.
• While time limits exist for filing appeals at various fora, substantial delays were seen in revenue’s appeal filings, as highlighted by a recent case with a 274-day delay in filing a Special Leave Petition (SLP) before the Supreme Court.
• Prolonged litigation that lacks closure certainty costs taxpayers and the tax administration a significant amount of time and effort.
• The tax administration may introduce timelines for the disposal of appeals at the first appellate authority stage, akin to the timelines set by the dispute resolution panel for managing taxpayers’ concerns.
• To expedite the litigation process and provide certainty, the tax administration may establish a comprehensive policy framework for appeals at higher fora (Tribunal, High Court and Supreme Court). This framework could include designated authorities responsible for timely filing and diligent prosecution of appeals.

Recommendation #3: Rationalising litigation relating to charitable trusts

• Despite their complete income tax exemption, charitable trusts often generate incidental income from activities aligned with their charitable purposes. This has been the subject of litigation in the past, ranging from registration procedures to fund applications.
• As an alternative to complete income tax exemption, the tax policy administration may consider implementing a concessional tax approach for charitable trusts. Under this regime, charitable trusts can benefit from lower tax rates compared with standard tax rates.
• The aim of the new regime should be to reduce the administrative burden associated with tax filings and documentation by simplifying compliance requirements for charitable trusts. This can enhance revenue collection without incurring litigation costs.
• The guidelines may also cover specific aspects of income treatment, accommodating both accrual and receipt bases. Giving charitable institutions the flexibility to choose the basis that best suits their operational needs and objectives will allow them to tailor their taxation