The Finance Bill 2017 proposes certain significant amendments in respect of the direct tax regime, especially in the area of M&A and restructuring / reorganisation. While some of the suggested changes are designed to ensure that the provisions are not abused by taxpayers through aggressive tax planning, the Finance Bill also attempts to provide much needed clarity on certain long-standing issues. This blog post briefly deals with some of the key points regarding restructuring / reorganisation and M&A transactions.

A. Anti-abuse provisions

1.  Deemed income on receipt of monies and property:

The Finance Bill provides that any sum of money, immovable property or any other property received without consideration or for inadequate consideration shall be deemed to be taxable in India as other income if the value of such receipt exceeds INR 50,000. This provision proposes to widen the existing provisions significantly by making it applicable to all kinds of taxpayers. Though the proposed provision inter alia creates a specific carve-out for certain specific M&A transactions, certain other transactions like transfer of a capital asset from a holding company to its subsidiary company and vice versa (these transactions are non-taxable transfers under the extant provisions, subject to fulfilment of certain conditions) have not been extended such benefits. This may impact internal restructurings in a big way and could result in unnecessary litigation.

2.  Deemed consideration for unquoted shares

The Finance Bill 2017 also proposes that in case an unlisted share is transferred at a value less than the fair market value (determined in a manner as may be prescribed), the fair market value shall be considered as the consideration for the purpose of computing capital gains. This proposal could adversely impact internal restructuring and reorganisation. However, Ii may still be possible to transfer unquoted shares (forming part of an undertaking) by way of a slump sale or as a gift.

Transfer of unquoted shares at a value less than fair market value could lead to double taxation of the same income, i.e. in the hands of the transferor and the transferee respectively. It may be noted that the method of determination of fair market value has not yet been notified.

3.  Introduction of ‘Thin Capitalisation’

As discussed in our March 1st post on this subject, accepting the recommendation under Action Plan 4 of the BEPS Report, ‘thin capitalisation’ provisions are being introduced through which any interest expense being paid or payable by an Indian taxpayer to its non-resident associated enterprise will be restricted to the lower of (i) 30% of its earnings before interest, taxes, depreciation and amortisation or (ii) interest paid or payable to the associated enterprise. Further, thin capitalisation shall also be attracted and a debt shall be deemed to have been issued by an associated enterprise, where such associated enterprise provides any implicit or explicit guarantee to the lender, or deposits a corresponding and matching amount of funds with the lender on the basis of which debt is provided to the taxpayer.

This proposal is likely to impact the capital structuring in a number of instances especially for enterprises engaged in capital intensive sectors, which may find it difficult to procure funds from sources outside the group.

4. Secondary adjustments under transfer pricing

The Finance Bill proposes that in case any primary adjustment on account of transfer pricing is made: voluntarily by the taxpayer; made by the tax authorities and accepted by the taxpayer; is determined in accordance with an advance pricing agreement mechanism, safe harbour rules, or through mutual agreement procedure, the tax payer would be required to make secondary adjustments to his income. In other words, the taxpayer shall have to carry out an adjustment in its book of accounts to ensure that the allocation of profits to the taxpayer is consistent with the transaction value determined through the primary adjustment. In case the amount representing primary adjustment is not repatriated into India, such amount would be treated as an advance and imputed interest on the same would be treated as the income of the taxpayer.

5.  Restricted capital gains exemption

Under the existing provisions of the Income Tax Act, 1961, long term capital gains arising from transfer of equity shares is exempt from tax, provided such transfer takes place on a recognised stock exchange and it is subject to security transaction tax. Such exemption of long term capital gains, were being misused to convert unaccounted money into legal money. Thus, in order to curb such unscrupulous activities it is proposed that the exemption shall be limited to situations where security transaction tax was paid at the time of acquisition of such equity shares. While the explanatory memorandum clarifies that this is an anti-abuse provision being introduced to prevent fictitious transactions, unless such situations are clarified, it may impact certain genuine investment transactions like domestic private equity investments, strategic investments by domestic investors, preferential allotments to certain investors including financial institutions, shares acquired through off market transactions, and shares allotted under an employee stock option scheme, etc.

It is pertinent to note that no exceptions have been provided for non-residents on any of the above issues. These provisions seem to be saddled with uncertainties and one hopes that they are appropriately addressed before they come into effect or else they could severely impact internal group reorganisation / restructurings involving non-resident investors.

B. Other important changes

To remove ambiguity surrounding the taxation of conversion of compulsorily convertible preference shares, the Finance Bill proposes to clarify that such conversion would not be construed as a taxable transfer for the purposes of capital gains. Moreover, the period of holding the converted shares shall be computed from the date of acquisition of the original preference shares and similarly, the cost of acquisition would be the cost at which such preference shares were acquired.

Besides the above mentioned changes the Finance Bill also seeks to clarify that in the case of a tax neutral demerger of a foreign company, where shares of an Indian company are transferred by the demerged foreign company to the resulting foreign company, the cost of acquisition of the shares in the hands of such resulting company (for subsequent transfers of such shares) shall be the same as that in the hands of such demerged company. Also, based on representations made by the foreign portfolio investors and other non-resident investors, the Finance Bill intends to exempt specified FII/FPIs from the applicability of indirect transfer related provisions.

Thus, in addition to introducing specific anti-abuse provisions, the Finance Bill also brings much needed clarity and certainty on certain contentious issues.

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