Highlights of Indian Tax Proposals in Finance Bill, 2011

By Aseem Chawla, Aurica Bhattacharya, and Priyanka Duggal

On February 28, 2011, India’s Finance Minister, the Honorable Pranab Mukherjee, unveiled the Finance Bill, 2011, which would make a number of significant changes in Indian tax law.  The changes proposed in the Finance Bill, 2011 also aim in facilitating the introduction of the planned Direct Taxes Code (“DTC”) and the Goods & Service Tax (“GST”).

The DTC proposes to introduce a modern and lucid direct tax legislation scheme aligned with internationally accepted best practices.  In addition, the proposed GST represents an ambitious plan to subsume most indirect tax legislation, including but not limited to the central excise, service tax, and value added tax.

Direct Tax Proposals

With respect to direct taxes, the Bill proposes a marginal increase in the basic exemption limit for individual taxpayers.  While the rate of surcharge would be reduced from 7.5% to 5%, the proposed increase in the minimum alternate tax from 18% to 18.5% could hurt industries, particularly those eligible for tax holiday incentives.  The Bill also extends the applicability of minimum alternate tax to include hitherto exempt special economic zone developers and units.  Furthermore, special economic zone developers would be subject to a tax at the rate of 15% on dividends distributed to their shareholders.

The Bill also seeks to introduce an alternate minimum tax on limited liability partnerships.  The proposal to tax foreign dividends received by an Indian company from a subsidiary of the foreign company at an incentivised rate of 15% over the present corporate tax rate would encourage outbound investments.

The Bill also introduces a number of administrative and substantive measures to counter tax abuse and reduce tax avoidance, such as extending the transfer pricing regime to transactions by residents with parties located in notified offshore jurisdictions.  It also proposes to mandate the filing of annual information by the liaison offices of foreign entities in India.

Indirect Tax Proposals

The Bill has made an effort to streamline the provisions of all indirect tax laws by eliminating various exemptions and aligning duty structures, in order to increase taxation of goods and services.  The ultimate objective is a smooth transition to GST. Since the proposed GST envisages a single rate of tax for all indirect tax laws, provisions have been introduced to align duty structures of various laws.  For example, the concessional excise duty rates and central sales tax rates have been fixed at 5%.  Currently, the Value Added Tax (“VAT”)/sales tax on many goods in most states is also 5%.  Basic customs, excise and service tax rates remain at 10%.  130 items that were hitherto exempt are now taxable under the excise tax at the rate of 1%.

One of the most important changes made under the service tax laws is the introduction of “point of taxation rules,” which would change the basis of tax collection from receipt basis to accrual basis, consistent with the existing  provisions of excise and sales tax laws.

The service tax net has also been expanded with the introduction of new taxable services, such as services rendered by restaurants serving alcohol and short term accommodation provided by hotels   In addition, the scope of many services has been expanded, including healthcare, legal, air travel, and life insurance.  Of note, the scope of legal services that are taxable has been considerably expanded.

In a nutshell, the Finance Minister has reaffirmed his commitment to introduce the Direct Taxes Code and the Goods & Service Tax, which, if passed, would bring an unprecedented change in the fiscal policy regime.  The proposals seek to further simplify and improve voluntary tax compliance and at the same time, deter tax evasion and take serious measures in situations where unethical practices have been followed.  For the moment, the big bang tax reforms are being eagerly awaited.

Mr. Aseem Chawla is the practice leader, and Ms. Aurica Bhattacharya and Ms. Priyanka Duggal are associates with the tax practice group at Amarchand & Mangaldas & Suresh A. Shroff & Co in New Delhi. They can be contacted at aseem.chawla@amarchand.com; aurica.bhattacharya@amarchand.com; and priyanka.duggal@amarchand.com.

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