India: Yearly Rewind: Taxation

TAXATION

The year 2023 has been noteworthy from an Indian direct tax perspective as significant rulings have been pronounced on certain controversial issues. The rulings will have a far-reaching impact on the taxpayers, with some outcomes being beneficial and others having adverse effects. The Union Budget 2023-24 also amended certain provisions under the Income-tax Act, 1961 (IT Act), which will impact taxpayers, especially non-resident taxpayers. On the indirect tax front, the Goods and Services Tax (GST) Council has paved the way for formation of the much-awaited GST Tribunal. GST on online gaming and secondment of personnel continues to be a burning issue with a flurry of show cause notices, tax demands and circulars/ clarifications from the tax authorities. The Foreign Trade Policy (FTP) 2023 was announced on 01 April 2023, which was long due since the FTP 2015-20 was extended year on year due to the Covid-19 pandemic. In this memo, we have captured the relevant updates on topical issues having a continuing impact on taxpayers.

Direct tax

Protocol allowing benefits under the MFN clause is not automatic, issuance of a notification is a pre-condition

The Supreme Court (Apex Court) ruling on treaty interpretation with a specific reference to the most favored nation (MFN) clause contained in various Double Taxation Avoidance Agreements (DTAA) entered by India with Organization for Economic Cooperation and Development (OECD) member countries¹ will have far reaching impact on taxpayers.

The Apex Court ruled that a notification under section 90(1) of the IT Act is a necessary condition to give effect to a DTAA or any protocol issued under the relevant DTAA (such as the MFN clause), to seek benefit of any beneficial clause extended to a third country. Also, the MFN clause can be invoked only if the third country was an OECD member country while entering into the DTAA with India. This ruling redefines the interpretation of MFN clause, applicability of treaty benefits and will certainly result in increased scrutiny from the Indian tax authorities.

This ruling will certainly impact the manner in which each DTAA is interpreted. It will affect entities/ individuals who would have either not paid taxes or paid taxes at a lower rate by seeking benefit under the MFN clause. This will also have an impact on the pending assessments, and may trigger initiation of re-assessment proceedings, wherever the limitation period permits.

Determination of Arms-Length Price (ALP) can be the subject matter of scrutiny by the High Court

The Apex Court has ruled on the manner in which transfer pricing related adjudication will be undertaken.² The question before the Apex Court was whether in every case where the Tribunal determines the ALP, the same shall attain finality and whether the High Courts are precluded from re-determining the ALP. It was contended by the taxpayers that determination of ALP is a factual exercise and the same cannot give rise to a substantial question of law unless perversity is demonstrated. Additionally, it was contended that a factual finding may give rise to a substantial question of law, inter alia, only in the event the findings are based on (i) no evidence; (ii) while arriving at the said finding, relevant admissible evidence has not been taken into consideration or inadmissible evidence has been taken into consideration; (iii) legal principles have not been applied in appreciating the evidence; or (iv) when the evidence has been misread.

The Apex Court ruled that determination of ALP outside the relevant provisions or the guidelines, can be considered as perverse, and perversity itself can be said to be a substantial question of law. When the determination of ALP is challenged before the High Court, it is always open for the High Court to consider and examine whether the ALP has been determined taking into consideration the relevant guidelines or not. Thus, there cannot be any absolute proposition of law that in all cases where the Tribunal has determined ALP, the same is final and cannot be the subject matter of scrutiny by the High Court.

Determination of ALP is a fact-finding exercise which involves a significant amount of data. This exercise, when undertaken by the High Court, will only increase the existing pendency of matters and will certainly extend the timelines of the entire litigation, which will adversely affect the taxpayer.

Tax Residency Certificate (TRC) conclusive to claim treaty benefits

The year 2023 was the year of re-affirming the settled position with respect to the finality of TRC when dealing with gains on exit of investments that were claimed as not taxable in India due to the DTAA benefit. Under the IT Act, a non-resident investor can claim non-taxability of capital gains in India on the basis of DTAA provisions, if any, if such non-resident furnishes a TRC. In early 2023, the Hon'ble High Court of Delhi³ in the context of India-Singapore DTAA held that the Income-tax department cannot question the TRC issued by other jurisdictions, as the same is sufficient evidence to claim treaty eligibility and to prove the residential status of the non-resident. While arriving at this position, the High Court relied upon the rulings of the Apex Court⁴ and the circulars⁵ issued by the Central Board of Direct Taxes (CBDT). Similarly, the Bombay High Court⁶ in the context of Indi- Mauritius DTAA has taken the same position that TRC is conclusive evidence to claim the treaty benefits, unless illegality or fraud has been alleged and demonstrated (which was not done in the present case).

This ruling of the Delhi High Court has been followed by the Delhi Tribunal in various cases during the year 2023. A re-affirmation on the conclusiveness of the TRC will certainly repose the faith of foreign investors in the tax system of India. Recently, the Apex Court has stayed the order of the Delhi High Court in the case of Blackstone. It would be interesting to see the manner in which this issue gets settled, as the Apex Court itself had upheld the validity of TRC for claiming treaty benefits in the past.

Dividends subject to dividend distribution tax (DDT) cannot claim benefit of tax treaty rate

There was uncertainty on whether the tax rate applicable to dividends declared to a non-resident shareholder, should be at the rate provided under section 115-O (provision applicable to DDT) of the IT Act or at the reduced rates under the tax treaty. This issue was ruled in favor of the taxpayer by the Delhi Tribunal⁷ and the Kolkata Tribunal⁸, which decisions were subsequently doubted for being incorrect by the Mumbai Tribunal. Hence, this issue was referred to the special bench of the Mumbai Tribunal.

The first issue before the special bench⁹ was whether the DDT is a tax on the domestic company or on the shareholder, or is it a tax which is paid on behalf of the shareholder. Having placed reliance on the ruling of the Bombay High Court¹⁰ and section 115-O (it was stated that this provision is a complete code in itself and does not have any features of withholding provisions, wherein tax is deducted on behalf of the payee), the special bench held that DDT is a tax on the profits of the company and not a charge in the hands of the shareholder or a tax paid on behalf of the shareholder by the domestic company.

The second issue was whether there is any double taxation in the context of DDT to give effect to tax treaty provisions. On this issue, the special bench held that a tax treaty is seen from a recipient's perspective and thus, in order to claim benefit under a tax treaty, the non-resident should be taxed in India. However, in the present scenario, DDT is levied on the income of the company which is a resident of India, and is not tax which is paid on behalf of the shareholder. In such circumstances, the domestic company paying DDT does not enter the domain of the tax treaty at all, unless a specific provision has been agreed between the two contracting states, similar to the one provided under the India-Hungary tax treaty.

Though DDT has been abolished from 2020, then this ruling will impact those taxpayers, who have claimed refund of the excess DDT by seeking a benefit under the tax treaty.

Increase in tax rate on royalty and Fees for Technical Services ('FTS') leads to unwarranted consequences on non-residents

One of the key amendments in the Finance Act, 2023 impacting non-residents was increasing the rate applicable to taxation of royalty and FTS. As per the amendment, the tax rates have been increased from 10% to 20%. The general tax rates applicable to royalty and FTS under most of the DTAA's is 10% and thus, non-residents were not required to claim the benefit of the DTAA on these sources of income. If the DTAA benefit was not claimed, non-residents were not required to undertake various compliances under the IT Act such as filing return of income (if royalty and FTS were the only source of income and appropriate taxes were withheld) or obtaining of permanent account number (PAN) or furnishing of relevant documents to claim DTAA benefit.

However, with this amendment in place, non-residents/ foreign companies will now be required to claim the benefit of the reduced rate prescribed under the DTAA. However, such a claim will result in additional compliance burden (like furnishing of TRC, Form 10F, no permanent establishment certificate, obtaining PAN and filing return of income) and the risk of scrutiny, if any, by the Income Tax Department (ITD). Moreover, now the non-residents should also be cognizant of various anti-avoidance provisions, which may be invoked by the ITD. This amendment not only burdens non-residents/ foreign companies, but it is equally harsh on the resident payers, if grossing up of tax has been agreed between the partes.

Share premium exceeding fair market value (FMV) in unlisted companies taxable even if received from non-residents (Angel tax)

Taxation of share premium (section 56(2)(viib)), popularly known as Angel Tax, is a tax levied on an unlisted Indian company if it receives consideration for issue of shares in excess of FMV. This provision was introduced in 2012 and was made applicable to share premium received from resident shareholders only. However, with the Finance Act, 2023, this provision has been extended to share consideration received from non-resident shareholders as well. Thus, if an unlisted Indian company is receiving consideration for issuance of shares in excess of its FMV, such excess amount is deemed to be the income of the Indian company and taxable as "Income from Other Sources" at the applicable corporate tax rates.

Applicability of share premium provisions to non-residents may pose valuation concerns for Indian domestic companies. As per the current exchange control regulations, shares can be issued to any non-resident at a price which is at FMV or above FMV. Thus, issuance of shares below FMV is not permissible under the exchange control regulations. Whereas, under the IT Act, if shares are issued above FMV, domestic companies will be liable to tax. Accordingly, for the purposes of IT Act, shares need to be issued at FMV or below FMV. Thus, valuation under the IT Act and exchange control regulations needs to align to ensure compliance under both the legislations.

To restrict the rigors of this provision, CBDT has issued two notifications¹¹, whereby the provisions will not be applicable to (i) start-ups duly registered with Department for Promotion of Industry and Internal Trade ('DPIIT') (which fulfills the required conditions); and (ii) classes of persons such as Government related investors, certain banks and certain non-resident investors coming from specified jurisdictions. Additionally, rules have also been issued providing for additional valuation methodologies.

Taxation of online gaming income

Online gaming has witnessed a huge surge in terms of participation on account of its recent popularity. To ensure that the winnings are taxed appropriately, legislators felt the need to introduce a separate income-tax regime to cover online gaming transactions. Section 115BBJ and section 194BA were introduced under the IT Act by the Finance Act, 2023. As per section 115BBJ, if the total income of a taxpayer includes any income by way of winnings from any online game, the same shall be taxed at 30%. The term 'online game' "means a game that is offered on the internet and is accessible by a user through a computer resource including any telecommunication device". Thus, the definition has a wide coverage and any game played on the internet will fall within the ambit of online game.

Corresponding to the charging provision, a tax withholding provision has also been introduced in the IT Act i.e., section 194BA, whereby any person responsible for paying to any person income by way of winnings will be required to withhold taxes on the net winnings at the applicable rates. Provisions have also been included for winnings in kind, and responsibility has been cast upon the payer to ensure that taxes have been paid. Clarity is required to ensure that non-residents do not face unwarranted consequences as it is unclear whether 'person' includes non-residents as well.

CBDT has also notified rules for computation of 'net winnings' for the purposes of taxation and withholding provisions.

Tax Collected at Source (TCS) on Liberalized Remittance Scheme (LRS)

In the recent past, applicability of TCS¹² under the IT Act has been consistently expanded. Various transactions have been included within the ambit of TCS and one such transaction is TCS on LRS payments. TCS on LRS remittance was introduced in 2020, with the TCS rate at 5% (if the amount remitted is in excess of INR 0.7 million (~USD 84 thousand)). Exceptions were made for remittance from loan obtained for educational purposes (TCS rate at 0.5%). Finance Act, 2023 increased the TCS rate from 5% to 20% and removed the threshold of INR 0.7 million, unless the remittance is for the purposes of education or medical treatment.

Considering that the removal of threshold would lead to unwarranted consequences, a circular was issued by the CBDT restoring back the monetary threshold of INR 7 lakhs. Thus, the revised TCS rates on LRS are as follows:

There has also been an amendment to the rules concerning current account transactions i.e., Foreign Exchange Management (Current Account Transactions) Rules, 2000, wherein international credit card spending abroad has been brought under the ambit of LRS. On account of this amendment, TCS provisions will be applicable on such usage. However, implementation of the amendment has been postponed.

Indirect tax

GST on online gaming

In a significant development for the online gaming industry, the GST Council in its 50th and 51st meeting held on 11 July 2023 and 02 August 2023, respectively, confirmed a GST levy of 28% on the face value of initial bets placed by users (excluding bets placed from the winning amounts). Vide this amendment, the GST laws have done away with the distinction between 'game of chance' and 'game of skill' and have applied a uniform rate for all online games. This marks a departure from the previous tax structure wherein an 18% GST was applied on the platform fee associated with skill-based games, whereas a 28% GST was applied for other online games, including betting and gambling. This change has led to a significant increase in the GST outgo for online gaming companies requiring a relook at the pricing/ fee structure and the overall operating model.

Even before the aforementioned changes were proposed and implemented, GST authorities had started to issue show cause notices to a few online gaming companies alleging that the predominant character of the games offered was 'game of chance' and hence attracted a higher GST rate of 28%. Post the amendments, issuance of show cause notices gained momentum with the initial view of GST authorities that the amendments are only clarificatory and hence the amended provisions applied even to periods prior to 01 October 2023. In a welcome move, the India Finance Minister clarified that these amendments are prospective and will be applicable only effective 01 October 2023. However, taxation for past periods will be determined by the Apex Court in the petition filed in the matter of Gameskraft. It is estimated that show cause notices aggregating to an approximate demand of over INR 1 trillion (~USD 12 bn) have been issued which have been challenged before various High Courts across India.

GST on secondment of employees

Applicability of GST on secondment/ deputation/ loaning of employees/ expats is a burning issue in India, resulting in issuance of show cause notices to several multinational companies operating in India. The heightened investigation by GST authorities is pursuant to an Apex Court judgment of May 2022 (Judgment) which held that service tax is payable (under the reverse charge mechanism) on transactions involving secondment of employees where salaries of seconded employees were reimbursed to the overseas parent.13 Although this judgment pertains to the service tax regime (pre-GST), implications squarely apply to the existing GST regime. It is basis this judgment that the tax authorities have been issuing show cause notices to various Indian subsidiaries of foreign companies having secondment arrangements.

Given the widespread impact, implication and involvement of large multinational organizations, multiple representations were filed before the Ministry of Finance to seek clarification and also to highlight the fact that show cause notices were being issued and the 'extended period of limitation' is being invoked by the GST authorities without appreciating the facts and similarity to the Apex Court judgment.

Taking note of these representations, the GST policy wing of CBDT has issued Instruction No. 05/2023-GST dated 13 December 2023 (Instructions).14 The Instructions provide the following observations/ guidance/ instructions for the GST authorities for investigating/ adjudicating the matter on taxability of secondment transactions:

1. The Apex Court has emphasized a nuanced examination based on the unique characteristics of each specific arrangement, rather than relying on any singular test.
   
   
2. There can be multiple types of secondment arrangement and in each such arrangement, the tax implications may be different depending on the specific nature of the contract and the terms/ conditions attached to such contract.
   
   
3. The Judgment should not be mechanically applied in all cases.
   
   
4. Investigation in each case requires careful consideration of its distinct factual matrix, including the terms of contract between overseas company and the Indian entity.
   
   
5. 'Extended period of limitation' cannot be involved merely on account of non-payment of non-payment of GST.
   
   
6. Only if the investigation indicates a material element of fraud, willful misstatement or suppression of facts, the 'extended period of limitation' can be invoked.
   
   
7. Evidence of such fraud, willful misstatement or suppression of facts should be made a part of the show cause notice.

The Instructions are a welcome and positive step. If the Instructions are indeed followed judiciously, it could help closure of various show cause notices and avoid any protracted litigation.

Clarification on levy of GST on personal and corporate guarantee

The GST Council in its 52nd meeting on 07 October 2023, recommended valuation rules and certain other clarifications relating to levy of GST on personal and corporate guarantees.

On personal guarantee by a director, the Reserve Bank of India (RBI) prohibits any direct and indirect payment to directors for providing personal guarantees. Therefore, in such a transaction, there is no consideration involved. However, even supply with no consideration can be deemed to be a supply if it is between related parties. The Central Board of Indirect Tax and Customs issued a clarification on 27 October 2023 stating that when no consideration is paid by a company to the director in any form, directly or indirectly, for providing a personal guarantee to the bank/ financial institution on their behalf, open market value of the said transaction/ supply may be treated as zero and hence no GST is payable.¹⁵ However, if such director is no longer connected to the management after giving a personal guarantee, any remuneration subsequently paid to such director shall be liable to GST.

GST on the corporate guarantee provided by a holding company to its subsidiary was also a burning issue, especially regarding taxability and valuation aspects. Post recommendation of the GST Council, a recent amendment (effective 26 October 2023) has been made to rule 28 of Central Goods and Services Tax Rules 2017 to prescribe the valuation principles for such supply of service.¹⁶ Vide the amendment, provision of corporate guarantee will be valued at 1% of the guarantee offered or the actual consideration, whichever is higher for levy of GST. This valuation principle will apply whether the service recipient is eligible for full input tax credit or not. This amendment will certainly increase the costs in certain industries where input credit of such tax cannot be availed.

Formation of Goods and Services Tax Appellate Tribunal (GSTAT)

In September 2023, the Finance Ministry announced the setting up of 31 benches of the much-awaited GSTAT across 28 Indian states and 8 Union Territories. GSTAT is the forum for second appeal in GST laws and the first common forum for dispute resolution on GST issues between the Centre and states. GSTAT will ensure that there is uniformity in redressal of disputes arising under GST, and thereby reducing multiple (contradictory) judgments on similar issues. Currently, the only mechanism available with taxpayers is to approach the High Court (writ mechanism) for any adverse order by the 1st appellate authority, with a request to either quash the order or to grant a stay on recovery. It is estimated that the number of appeals (under Central GST laws) pending adjudication is approximately 14,000 (and increasing) in absence of a functioning GSTAT.¹⁷ It is expected that once GSTAT starts functioning (sometime in 2024), it will expedite adjudication process, provide tax certainty in recurring litigative issues, reduce the burden on higher courts and assist in resolving disputes between the Centre and States.

Classification of LCD panels

The Apex Court in CCE Aurangabad v Videocon Industries Limited¹⁸ pronounced an important ruling on classification of liquid crystal display (LCD) panels under the Indian customs legislation. As per this ruling, LCDs should be classified under chapter 90 and not chapter 85 of the Customs Tariff Act, 1975.

The key question revolved around whether these panels should be categorized as 'parts of television sets' or should be considered independently. The tax authorities sought to classify LCD panels as 'parts of television sets', subjecting them to higher customs duties. However, the assessee argued for an independent classification under 9013.8010 of the Customs Tariff Act, 1975. In the judgment, the court mentioned that LCDs have diverse applications beyond television or audio sets. Importantly, chapter 85, as contended by the tax authorities explicitly excluded chapter 90, which specifically mentioned LCDs. Finally, the Apex Court held that classification of LCD must be in consonance with the headings in the chapter note. It determined that chapter 90 which mentions 'LCD panels' was more specific compared to the generic heading under HSN 8529 as suggested by the tax authorities. The court applied the general rules of interpretation which mention that headings that are specifically provided should prevail over the general headings.

This is a welcome ruling and puts to rest a significant controversy on classification of LCD which is an important import product for the IT and electronics industry in India.

Foreign Trade Policy 2023

The Ministry of Commerce & Industry announced the much-awaited FTP 2023.¹⁹ The previous FTP was for the period 2015-20 and was extended until March 2023 due to the Covid-19 pandemic. Unlike the previous FTPs which have a set tenure of 5 years, FTP 2023 is open-ended with no sunset clause. This will allow making revisions and changes on a need basis and to adapt to changing economic and trade conditions. FTP 2023 rests on the following four objectives:

1. Shifting from the traditional incentive based to a tax remission-based regime. FTP 2023 will focus on reducing the tax burden on exporters and not just provide financial incentives, which is also an area of concern under the World Trade Organization (WTO) norms.
   
   
2. Enhancing collaboration between States, Districts and Exporters to boost exports and increase competitiveness of Indian goods and services in global trade.
   
   
3. Reducing transaction costs, introducing e-initiatives and enhancing ease of doing business quotient.
   
   
4. Focusing on emerging areas such as e-commerce exports, developing districts as export hubs and streamlining the SCOMET policy.

FTP 2023 introduced several initiatives such as the one-time amnesty scheme for closure of pending authorizations, 'Towns of Export Excellence' scheme, enabling merchant trading from India, streamlining the Advance Authorization and EPCG schemes. It also emphasizes the use of IT systems with risk management systems for various approvals and encourages paperless and online processes.

WTO ruling on increased import duties on ICT Products

On 02 April 2019, the European Union (EU) challenged India's imposition of import duties on various Information and Communication Technology (ICT) products, ranging from mobile phones, integrated circuits to optical instruments. The challenge arose from the inconsistencies with certain WTO provisions. Subsequently, Chinese Taipei and Japan joined the dispute.

The complainants argued that India, as per its commitments in the General Agreement on Tariffs and Trade, 1994 (GATT), initially adhered to duty-free treatment for ICT imports. However, since 2014, India significantly raised import duties to as high as 20 percent, violating obligations under GATT. The WTO Panel held that this breach resulted in less favorable treatment, imposition of excess duties, and unfavorable conditions. In September 2023, both regions requested the WTO's dispute settlement body to defer adopting a ruling against India's import duties until December 2023, as bilateral talks were ongoing.

Despite efforts, the EU filed for the adoption of the panel report on 07 December 2023. India, in turn, appealed against the order on 08 December 2023 at the WTO. The appeal came after 7 months of unsuccessful negotiations for a mutually agreeable solution (MAS) between India and the EU. The EU, as part of the MAS, sought customs duty concessions on specific goods, which India found unacceptable.

India had increased import duties on ICT products to promote domestic manufacturing and limit cheaper imports. The potential adoption of WTO Panel's ruling could markedly affect the domestic ICT industry, potentially increasing the influx of international ICT products. Yet, the report's implementation is on hold until the conclusion of India's appeal as the WTO Appellate Body is not operational due to disagreements among member countries over member appointments. Despite the potential negative impact of the WTO ruling, there will be no immediate consequences for Indian industry, although it is necessary to keep watching this space.

Footnotes

1. Assessing Officer v. Nestle SA, 2023/INSC/928 (Supreme Court)

2. SAP Labs India Private Limited v. Income-tax Officer, 2023/INSC/394 (Supreme Court)

3. Blackstone Capital Partners (Singapore) v. ACIT, 2023/DHC/634 (Delhi High Court)

4. UOI v. Azadi Bachao Andolan, [2003] 263 ITR 706 (Supreme Court); Vodafone International Holdings B.V. v. UOI & Anr., [2012] 1 S.C.R. 573 (Supreme Court)

5. CBDT, Circular No. 682 (30 March 1994; CBDT Circular No.789 dated 13 April 2000.

6. Bid Services Division (Mauritius) Ltd. v. DIT, Writ Petition No. 713 of 2021 (Bombay High Court)

7. Giesecke & Devrient India Private Ltd. v. ACIT, [2020] 120 taxmann.com 338 (Delhi ITAT)

8. DCIT v. Indian Oil Private Petronas Ltd., [2021] 189 ITD 490 (Kolkata ITAT)

9. DCIT v. Total Oil India Private Ltd., [2023] 149 taxmann.com 332 (Mumbai ITAT)

10. Godrej & Boyce Manufacturing Co. Ltd. v. Deputy Commissioner of Income-Tax & Anr., [2017] 394 ITR 449 (Supreme Court)

11. CBDT, Notification No. 29 & 30 of 2023 (24 May 2023)

12. TCS is an additional amount collected as tax by a seller of specified goods from the buyer at the time of sale over and above the sale amount and is remitted to the government account

13. C.C.,C.E. & S.T. – Bangalore v. Northern Operating Systems Pvt. Ltd., Civil Appeal No. 2289-2293 of 2021 (Supreme Court)

14. Central Board of Indirect Taxes and Customs, Instruction No. 05/2023-GST (13 December 2023), access here.

15. Central Board of Indirect Taxes and Customs, F. No. 20/06/22/2023-GST-CBEC (27 October 2023), access here

16. Central Board of Indirect Taxes and Customs, Notification No. 52/2023- Central Tax, access here

17. Business Today, MoS Fin in Lok Sabha: Over 14,000 appeals relating to Central GST pending between April and June (07 August 2023), access here

18. CCE Aurangabad v. Videocon Industries Ltd., Civil Appeal No(S). 8026 of 2022 (Supreme Court)

19. Ministry of Commerce & Industry, Foreign Trade Policy (2023), access here

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.