2010
International Tax and Business Guide connecting you to worldwide information
India
A publication of Deloitte Touche Tohmatsu
India International Tax and Business Guide
Tax professionals of the member firms of Deloitte Touche Tohmatsu have created the Deloitte International Tax and Business Guides, an online series that provides information on investment conditions, tax regimes and regulatory requirements, along with information for executives working abroad. The Guides are supplemented by the Highlights series, an at-a-glance summary of basic information, including tax rates, for over 120 jurisdictions.
Contents 1.0 The investment climate 1.1 Economic structure 1.2 Banking and financing 1.3 Foreign trade
2.0 Business regulations
2.1 Registration and licensing 2.2 Price controls 2.3 Monopolies and restraint of trade 2.4 Intellectual property 2.5 Mergers and acquisitions
3.0 Foreign investment
3.1 Foreign investment incentives and restrictions 3.2 Exchange controls
4.0 Choice of business entity
4.1 Principal forms of doing business 4.2 Establishing a branch 4.3 Setting up a company
5.0 Business taxation
5.1 Overview 5.2 Taxable income and rates 5.3 Capital gains taxation 5.4 Withholding tax 5.5 Foreign income and tax treaties 5.6 Transactions between related parties 5.7 Turnover and other indirect taxes and duties 5.8 Other taxes 5.9 Tax compliance and administration
6.0 Personal taxation
6.1 Residency 6.2 Taxable income and rates 6.3 Special expatriate tax regime 6.4 Capital taxes
7.0 Labour environment
7.1 Employees’ rights and remuneration 7.2 Wages and benefits 7.3 Termination of employment 7.4 Labour-management relations 7.5 Employment of foreigners
8.0 Office Locations
1.0 The investment climate Political background India is a federal republic, with 28 states and seven federally administered union territories; it operates a multi-party parliamentary democracy system. Parliament has two houses: the Lok Sabha (lower house) and the Rajya Sabha (upper house). The President, the constitutional head of the country and of the armed forces, acts and discharges the constitutional duties on the advice of the Council of Ministers, which is headed by the Prime Minister. The Prime Minister and the Council of Ministers, in turn, are responsible to parliament and subject to the control of the majority members of parliament. The states and union territories are governed by independently elected governments. 1.1 Economic structure India’s economy has been among the fastest growing economies in recent years. This growth has been supported by market reforms, large inflows of foreign direct investment, rising foreign exchange reserves, a booming information technology and real estate sector and a flourishing capital market. The recent global economic slowdown had its impact on the Indian economy with the real GDP growth rate for fiscal year ending 31 March 2009 coming down to 6.3%. However, there are indications that the worst is behind and the economic indicators in the first three quarters of the 2009-10 fiscal year has shown positive results on most fronts with declining unemployment, increasing growth of the industrial sector and a booming capital market. The estimated real GDP growth rate for fiscal year ending 31 March 2010 is estimated to be at 7.2%. India is a three-tier economy, comprising a globally competitive services sector, an emerging manufacturing sector and an agricultural sector. The services sector has proved to be the most dynamic in recent years, with trade, hotels, transport, telecommunications and information technology, financial, real estate and business services registering particularly rapid growth. 1.2 Banking and financing India’s central bank is the Reserve Bank of India (RBI), which is the supervisory authority for all banking operations in the country. The RBI has responsibility for banking sector development and regulations, currency and credit flow management, foreign exchange management and ensuring monetary stability. It is responsible for regulating non-banking financial services companies (NBFCs), which operate like banks but are otherwise not permitted to carry on the business of banking. The RBI also acts as a banker to the government. The financial and commercial centre is Mumbai, and there are proposals to develop this area further as an International Financial Centre. The banking sector in India is broadly represented by public sector banks (where the government owns a majority shareholding and includes the State Bank of India and its subsidiaries after transfer of the shares by the RBI to the Indian government); private sector banks; foreign banks operating in India through their branches/wholly owned subsidiaries; and co-operative banks, which usually are regional. Stringent rules govern the operations of systemically important non-deposit taking NBFCs, such as those with assets of INR 1 billion or more, to reduce the scope of regulatory arbitrage vis-àvis a bank. Capital markets India has a well-established and well-regulated stock market. The Securities and Exchange Board of India (SEBI) is the independent, statutory regulatory authority with responsibility for regulating and developing the capital market. The Bombay Stock Exchange and the National Stock Exchange of India are the two largest stock exchanges. India’s capital markets have experienced sweeping changes and the market infrastructure has advanced. In addition to advancements in the capital market, the regulatory and oversight norms have improved over the years, ensuring a sound and stable market. 1
The government has liberalised the guidelines for listing foreign companies on Indian stock exchanges (up to 49% in infrastructure companies in the securities markets - with a separate foreign direct investment cap of 26% and foreign institutional investor (FII) cap of 23%). Indian companies already listed on Indian stock markets may be listed on foreign stock exchanges if certain conditions are satisfied. Moreover, foreign investments in stock exchanges have been allowed, new derivative instruments have been introduced and interest rate futures have been allowed since 31 August 2009. Other players active in investing and financing in companies include private equity investors, foreign institutional investors, venture capital funds, foreign venture capital investors and mutual funds (both Indian and foreign). 1.3 Foreign trade India’s declining rate of trade with the U.S. has been offset by an increased rate of trade with the EU and other countries. Although India’s major exports have long been textiles and re-exported gems, the country has recently seen significant exports of chemicals, automotive components and petroleum products including coal. India’s largest imports are petroleum and related products. With import liberalisation, electronics, capital goods in construction, engineering products and gold imports also have registered growth. However, the global slowdown has resulted in negative export growth for the country with exports declining. India maintains complex procedures and documentation requirements for both imports and exports.
2.0 Business regulations 2.1 Registration and licensing Foreign investment is freely permitted except in a few sectors. Foreign direct investment is made through two routes: automatic approval and government approved. Under the automatic route, the foreign investors or the Indian company do not need the approval of the RBI or the Indian government. The recipient simply must notify the RBI of the investment and submit documents with the required details to the RBI/authorised dealer. Where there are sector-specific caps, proposals for stakes up to those caps are automatically approved, with a few exceptions. Foreign direct investment is allowed under the automatic route in all sectors, except those specifically listed as requiring government approval. Proposed investments that do not qualify for automatic approval must be submitted to the Foreign Investment Promotion Board (FIPB) - for example: courier service, cigar and cigarettes manufacturing, trading of items sourced from small sectors, the tea sector, etc. Wholly owned subsidiaries of foreign companies may be established without prior FIPB approval, but only in sectors where automatic clearance is already granted for foreign direct investment. The government has established norms for indirect foreign investment in Indian companies, according to which an investment by a foreign company through a company in India that is owned or controlled by a nonresident entity would be considered as foreign investment. Guidelines for downstream investment by investing companies owned or controlled by nonresidents in other Indian companies also have been issued. The Secretariat for Industrial Assistance (SIA), which operates within the Ministry of Commerce and Industry, issues industrial licences, provides information and assistance to companies and investments, monitors delays and reports all government policy relating to foreign investment and technology. Investors may file a package application covering both the licence and the foreign investment with the SIA or the FIPB. The normal processing time is up to three months.
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Special rules apply to FIIs, pension funds, mutual funds, asset management companies, institutional portfolio managers, etc., which are permitted to invest in Indian capital markets. FIIs are required to register with SEBI. 2.2 Price controls The central and state governments have passed legislation to control production, supply, distribution and the price of certain commodities. The central government is empowered to list any class of commodity as essential and can regulate or prohibit the production, supply, distribution, price and trade of these commodities for the following purposes: maintain or increase supply; equitable distribution and availability at fair prices; and secure an essential commodity for the defence of India or the efficient conduct of military operations. 2.3 Monopolies and restraint of trade India’s markets are monopolised in only a few areas reserved for the public sector, such as postal services, defence, atomic energy and railways. The government is considering gradual private participation in areas reserved for exclusive state ownership. The emphasis is to develop viable projects on public-private participation mode. Monopolies are rare in activities open to the private sector. The Monopolies and Restrictive Trade Practices Act 1969 (MRTP Act) prohibits restrictive and unfair trade practices. The Competition Act 2002 prohibits anti-competitive agreements, including the formation of cartels and sharing of territories, restriction of production and supply, collusive bidding and bid rigging and predatory pricing. The following practices are considered objectionable if they lead to a restriction of competition: tie-in arrangements that require the purchase of some goods as a condition of another purchase; exclusive supply or distribution agreements; refusal to deal with certain persons or classes of persons; and resale price maintenance. There are rules prohibiting abuse of a dominant position and regulations for certain business combinations. The Competition Commission prevents such practices from having an adverse effect on competition, promotes and sustains competition in markets, protects the interests of consumers and ensures freedom of trade carried on by other participants in markets in India. Although several provisions have been brought into force, the operating provisions in the Competition Act are not yet effective. Once the Competition Act is fully effective, the MRTP Act will be repealed. 2.4 Intellectual property Indian legislation covers patents, copyrights, trademarks, geographical indicators and industrial designs. The Patent Act 1970 has been amended several times to meet India’s commitments to the World Trade Organisation (WTO), such as increasing the term of a patent to 20 years. Trademarks can be registered under the Trade Marks Act, 1999, which provides for registration of trademark for services in addition to goods, simplifies procedures, increases the registration period to 10 years and provides a six-month grace period for the payment of renewal fees. Copyrights are protected on published and unpublished literary, dramatic, musical, artistic and film works under the Copyright Act 1957. Subsequent amendments have extended protection to other products such as computer software and improved protection of literary and artistic works and established better enforcement. The protection term for copyrights and rights of performers and producers of phonograms is 50 years. India is a signatory to the Paris Convention for the Protection of Industrial Property and the Patent Co-operation Treaty, and it extends reciprocal property arrangements to all countries party to the convention. The convention makes India eligible for the Trademark Law Treaty and the Madrid Agreement on Trademarks. The country also participates in the Bern Convention on Copyrights, the Washington Treaty on Layout of Integrated Circuits, the Budapest Treaty on Deposit of Micro-organisms and the Lisbon Treaty on Geographical Indicators. As a member of the WTO, India enacted the Geographical Indications of Goods (Registration & Protection) Act (1999).
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2.5 Mergers and acquisitions Mergers and acquisitions are generally governed by the Companies Act, 1956 and sectorspecific law, such as telecoms, insurance, pension and banking. The provisions of Listing Agreements with the stock exchange, SEBI (Disclosure & Investor Protection Guidelines), 2000 and SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 must be complied with in the case of listed companies. If a merger has cross-border aspects, the parties must comply with, among others, the foreign direct investment policy of the government - the Foreign Exchange Management Act, 1999. The Competition Act also seeks to regulate specified combinations. Indian companies are permitted to acquire businesses/companies abroad if certain conditions are satisfied. Broadly, the transfer of business/assets requires the approval of the shareholders of a company. This can be done with the additional procedure of court approval or can be a simple shareholders’ approval without court approval, depending on the manner of the transfer. A reorganisation involving the amalgamation of companies or a tax neutral demerger would require formal High Court approval, as well as the approval of shareholders and creditors and the Regional Director of the Ministry of Corporate Affairs and Official Liquidators, if the result of the amalgamation is that one of the companies is to be liquidated/dissolved. If the transferor or transferee company or both are listed on a recognised stock exchange, the draft reorganisation proposal requires prior approval of the stock exchange before application is made to the High Court. In the case of an acquisition or change in control of a listed company, the acquirer must provide an exit opportunity to the shareholders through a timely public offer with appropriate disclosures. In prescribed cases, no exit option is required, subject to conditions (such as including an inter se transfer of shares between the promoter and the foreign collaborators and intergroup transfers). The government can order the amalgamation of two or more companies if this is in the public interest. The Board for Industrial and Financial Reconstruction can issue an order under the Sick Industrial Companies (Special Provisions) Act, 1985 for the amalgamation of an ailing industrial company with another company. The tax benefits of corporate reorganisations are discussed below at 5.2.
3.0 Foreign investment 3.1 Foreign investment incentives and restrictions Many foreign companies use a combination of exporting, licensing and direct investment in India. India permits 100% foreign equity in most industries. Units setting up in special economic zones (SEZs), operating in electronic hardware or software technology parks or operating as 100% export-oriented units, may also be fully foreign-owned. Nevertheless, the government has set sector-specific caps on foreign equity in certain industries, such as basic and cellular telecommunications services, banking, civil aviation and retail trading. India’s investment incentives are designed to channel investments to specific industries, promote development of economically lagging regions and encourage exports. The country offers a number of inducements, including tax and non-tax incentives for establishing new industrial undertakings; incentives for specific industries such as power, ports, highways, electronics and software; incentives for units in less-developed regions; and incentives for units producing exports or in export processing zones and SEZs. Incentives include the following:
Tax holidays, depending on the industry and region;
100% deductions for research and development (R&D) expenses, including capital outlays (other than those for land) in the year incurred. Companies also can a claim deduction for expenses incurred in the three years immediately preceding the year in which the company commenced business; and 4
Accelerated depreciation for certain categories, such as energy-saving, environmental protection and pollution control equipment.
The central government’s development banks and the state industrial development banks extend medium- and long-term loans and sometimes take equity in new projects. Some Indian states provide additional incentives. 3.2 Exchange controls The government sets India’s exchange control policy in conjunction with the RBI, which administers foreign exchange (forex) regulations. The Foreign Exchange Management Act of 2000 (FEMA) established a simplified regulatory regime for forex transactions and liberalised capital account transactions. It has also appointed the RBI as the sole monitor of all capital account transactions. The rupee is fully convertible on the current account. Forex activities are permitted unless specifically prohibited. The RBI allows branches of foreign companies operating in India to freely remit net of tax profits to their head offices through authorised forex dealers subject to RBI guidelines. Forex cover can be obtained for all genuine transactions from authorised dealers.
4.0 Choice of business entity 4.1 Principal forms of doing business The principal forms of doing business in India are the limited liability company (public or private); partnership or limited liability partnership; association of persons; representative office, branch office, project office or site office of a foreign company; or trust. Foreign investors may adopt any recognised form of business enterprise. The limited liability company is the most widely used and the most suitable form for a foreign direct investor. The formation, management and dissolution of limited liability companies is governed by the Companies Act 1956 (Companies Act), which is administered by the Ministry of Corporate Affairs (MCA) through the Registrar of Companies (ROC), Regional Director, Company Law Board and Official Liquidator. Companies Companies are broadly classified as private limited companies and public limited companies. Companies may have limited or unlimited liability. A limited liability company can be limited by shares (liability of a member is limited up to the amount unpaid on shares held) or by guarantee (liability of a member is limited up to the amount for which a guarantee is given). Companies limited by shares are a common form of business entity. Public limited companies can be closely held unlisted or listed on a stock exchange. A private company is one that, by virtue of its articles of association prohibits any invitation to the public to subscribe for any of its shares or debentures; prohibits any invitation or acceptance of deposits from persons other than members, directors and their relatives; restricts the number of members to 50 (excluding employees and former employees); and restricts the right to transfer its shares. A public company is a company that is not a private company. A public company may offer its shares to the general public and no limit is placed on the number of members. A private company that is a subsidiary of a company that is not a private company is also a public company. However, the status of a private subsidiary with more than one shareholder, where one is a foreign corporate body (holding company) and the other shareholder is not, depends on the status of its holding company. A “section 25” company is a company formed for the purpose of promoting commerce, art, science, religion, charity or other useful objective. A section 25 company is not permitted to pay dividends to its members, it must be licensed by the government and can be a private company or public company that is either limited by shares or guarantee. 5
An overview of important provisions in the Companies Act follows. Capital. A public limited company must have a minimum paid-up capital of INR 500,000. The minimum paid-up capital for a private company is INR 100,000. Types of share capital. There are two types of shares under the Company Law: preference and equity. Preference shares carry preferential rights in respect of dividends at a fixed amount or at a fixed rate before the holders of the equity shares can be paid, and also carry preferential rights with respect to the repayment of capital on winding up or otherwise. In other words, preference share capital has priority both in repayment of dividends and capital. The tenure of preference shares is a maximum of 20 years. Equity shares are shares that are not preference shares. Equity shares can be shares with voting rights, or shares with differential rights as to dividends, voting or otherwise. A public company may issue equity shares with differential rights for up to 25% of the total share capital issued if it has distributable profits in the preceding three years and has complied with other requirements. Listed public companies cannot issue shares in any manner that may confer on any person superior rights as to voting or dividend vis-à-vis the rights on equity shares that are already listed. A private company may freely issue shares with differential rights as to dividends, voting or otherwise subject to the provisions of its articles of association. Securities can be held in electronic (dematerialised) form through the depository mode. In the case of a public/rights issue of securities of listed companies, the company must give investors an option to receive the securities in physical or electronic form. For shares held in dematerialized form, no stamp duty is payable on transfer of shares. Members, shareholders. An individual or legal entity, whether Indian or foreign, may be a shareholder of a company. A public company should have at least seven members; the minimum number of members in a private company is two and the maximum is 50 (excluding employees and former employees). Management. Public companies with paid-up capital of INR 50 million or more must appoint a managing director or a full-time director or manager. The term of a managing director/manager is a maximum of five years but may be renewed. Managing directors may hold that position in no more than two public companies. A public company with paid-up capital of INR 50 million or more must set up an audit committee. There is no requirement to appoint a managing director or a full-time director or manager for private companies. Board of directors. Only individuals may be appointed as directors. A public limited company must have at least three directors and a maximum of 12 (any increase requires approval of the MCA). A private company must have at least two directors. If a nonresident is appointed to any managerial position (i.e. managing director, full-time director, manager) in a public company, central government approval is required. Directors are elected by a simple majority or by methods provided in the articles of association. There is also a provision for appointment by proportional representation. Salaries and perquisites for directors of a public company are subject to ceilings and may require approval of the central government if the company has insufficient profits or losses. Board meetings, which may be held anywhere, must be held once per quarter. Barring certain exceptions, the board has full powers and may delegate its powers to a committee of the board. General meeting. An Annual General Meeting (AGM) of shareholders must be held at least once per calendar year and the time between two AGMs should not exceed 15 months. Among the business to be transacted at an AGM is approval by the shareholders of the audited financial statements for the financial year. The financial statements to be approved by the AGM cannot be older than six months from the date of the AGM. The financial year of a company may be less or more than a calendar year, but it cannot exceed 15 months (extendable by three months by the ROC). An Extraordinary General Meeting can be called by the board of directors at the request of holders of 10% of the paid-up share capital. A quorum is established when five members (two in the case of a private company), or more, according to a company’s articles, are present at a meeting. If a quorum is not present, then subject to the provisions of the articles of association, the meeting is adjourned until the following week, at which time all members present, regardless of number, constitute a quorum. 6
There are two kinds of resolutions: ordinary and special. An ordinary resolution may be passed by a simple majority of members present in person or represented by proxy. Special resolutions require at least a 75% vote and include proposals for liquidation, transfer of the company’s offices from one state to another, buyback of securities, amendment of articles of association and increases in intercorporate investment. Unless a poll is demanded by the chairman of the general meeting or by the specified number of shareholders or by the shareholders holding specified shares, the voting at a general meeting is done through a show of hands. Each shareholder has one vote on a show of hands. In the case of a poll, voting rights of a member are in proportion to his share of the paid-up equity capital. Preference shareholders have the right to vote only on matters that directly affect the rights attached to preference shares. Preference shareholders have the same rights to voting as equity shareholders if the dividend has remained unpaid for a specified period. Dividends. Dividends must be paid in cash and not in kind. Once declared the dividend must be paid within the stipulated time. Dividends for a financial year can be paid out of (a) profits of that year after providing for depreciation, (b) out of profits of any previous financial year(s) arrived at after accounting for depreciation and remaining undistributed profits or (c) from both. Losses or depreciation of earlier years (whichever is lower) must be adjusted from the profits before payment of dividends. Before declaring dividends from the current year’s profit, the company must transfer between 2.5% and 10% of its current profits to reserves, depending on the amount of dividends declared. The accumulated profits in the reserve may be utilised for payment of dividends, subject to conditions. Disclosure. Books of accounts must be maintained and open to inspection for directors, government officers or officers of the SEBI in the case of listed companies, and they must be kept for the preceding eight years. A company must appoint statutory auditors, who must be chartered accountants. Holders of shares or debentures must receive annual reports including audited balance sheets and profit-and-loss statements before annual meetings. Companies are required to file annual financial statements with the ROC, as well as an annual return, which contains particulars about the company’s shareholders and members, directors and share capital. Such information is available to the public for inspection. A private company is required to file its financial statements with the ROC, but its profit-and-loss account is not available to the public for inspection. Public companies listed on a stock exchange are required to publish their quarterly results in a local newspaper. Sole selling agencies. A company may appoint a sole selling agent for a maximum period of five years. If a company has paid-up capital of more than INR 5 million, central government approval is required for the appointment. The central government prohibits the appointment of a sole selling agent in certain industries in which demand substantially exceeds supply. Limited liability partnerships A limited liability partnership (LLP) is a body corporate, a legal entity separate from its partners and has perpetual succession. An LLP can be formed by two or more partners. An individual or a body corporate can be a partner in a LLP. An LLP is required to have at least two designated partners (DPs) who are individuals responsible for compliance with the provisions of the LLP Act and at least one of whom should be resident in India (i.e. present in India for at least 182 days in the preceding year). The DPs must obtain a Digital Signature Certificate (DSC) from the certifying authority for electronic filings and a Designated Partner Identification Number. As a separate legal entity, an LLP is liable to the full extent of its assets, whereas the liability of LLP partners is limited to their agreed contribution to the LLP. LLPs are governed by the Limited Liability Partnership Act, 2008 and administered by the MCA through the ROC, Company Law Board and Official Liquidator. A partnership firm, private company or unlisted public company can be converted into an LLP. Partnerships A partnership is an agreement between persons to share profits of a business carried on by any or all of them acting for all. The relationship between the partners is defined through the partnership deed. Each partner is liable to indemnify the firm for any loss caused to it by his/her fraud in the conduct of the business of the firm. Each partner is liable jointly with all other partners and also severally for all acts of the firm done while he/she is a partner. 7
Association of Persons An association of Persons (AOP) is a collection of different entities joined together for a common purpose. It can be formed by individuals, limited companies and others, and it need not register with the authorities. An AOP is usually formed by the execution of an agreement between the participants. However, in certain cases where a formal relationship may not be evident from documents, the conduct of the parties can give rise to a presumption of the existence of an AOP. The documents governing an AOP usually contain provisions for its internal management, administration, the distribution of income and the distribution of assets in a dissolution. An AOP is a recognised entity for tax purposes. 4.2 Establishing a branch In addition to establishing a wholly owned subsidiary (or setting up a joint venture in India), a foreign company may establish its presence in India by either setting up a liaison office, representative office, project or site office or branch. A liaison office, akin to a representative office, acts as a communication channel between the head office and the office in India. It may not carry on any commercial activities and its expenses must be met out of inward remittances from the head office. A liaison office may be permitted to promote export from or import to India, facilitate technical and financial collaboration between a parent company and its group companies in India, represent the head office in India, etc. Foreign companies engaged in manufacturing and trading may establish a branch in India for the following activities:
Export/import of goods (retail trading activity of any kind is strictly prohibited);
Rendering of professional or consulting services;
Carrying out research for the head office;
Promoting technical or financial collaboration between Indian companies and the head office or an overseas group company;
Representing the head office in India and acting as a buying/selling agent in India;
Rendering services in information technology and development of software in India;
Rendering technical support for products supplied by the head office/group companies; and
Foreign airline/shipping companies.
Eligibility criteria for setting up branch or liaison office center around the track record and net worth of the foreign parent. For a branch, the parent must have a profit-making track record in its home country during the immediately preceding five financial years (three years for establishing a branch). The foreign parent’s net worth cannot be less than USD 100,000 or its equivalent to establish a branch (USD 50,000 or its equivalent in the case of a liaison office). Net worth for these purposes is the paid up share capital plus free reserves minus intangible assets (computed as per the latest audited balance sheet or account statement certified by a certified public accountant or registered accounts practitioner). Additionally, in establishing a branch of a foreign company, a representative office or a liaison office, RBI approval and registration with ROC and prescribed documents (including financial statements) must be filed on an annual basis with ROC. Foreign companies planning to carry out specific projects in India may establish temporary project/site offices in India for the purpose of carrying out activities relating to the project. The RBI has granted general permission to establish such companies subject to specified requirements. If the company cannot meet the requirements, it must seek approval from the RBI before setting up. Project offices may not undertake or carry on any activities other than those relating and incidental to execution of the project. Once the project is completed and tax liabilities are met, the project office may remit any project surplus outside India.
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4.3 Setting up a company A foreign company can commence operations in India by incorporating a company under the Companies Act as a subsidiary (including a wholly owned subsidiary) or a joint venture company. Private or public companies are formed by registering the memorandum and articles of association and prescribed forms with the ROC in the state in which the registered office will be located. If the documents are in order, the ROC grants a certificate of incorporation. The filings for formation must be e-filed. A private company can commence its business immediately upon incorporation. A public company is required to obtain a Certificate of Commencement of Business from the ROC before starting its business operations. All directors or proposed directors must obtain a Director Identification Number. At least one director must also obtain a DSC from the certifying authority for electronic filings. Depending upon the nature of business activities and the business sector, companies also need to register with relevant sector regulators, such as:
Financing and investing operations, etc., must register with the RBI as a non-banking finance company (NBFC);
Asset reconstruction companies must register with the RBI;
Insurance services (life and non-life) and insurance broking companies, etc., must register with the Insurance Regulatory Development Authority;
Stock brokers, sub-brokers, merchant bankers, underwriters, custodians, portfolio managers, credit rating agencies, mutual funds, venture capital, asset management companies, share transfer agents, etc., must register with SEBI; and
Pension funds must register with the Pension Fund Regulatory and Development Authority.
5.0 Business taxation 5.1 Overview Taxes are levied in India at the national level and at the state level. The principal national taxes on companies are the corporate income tax, the minimum alternate tax, capital gains tax, dividend distribution tax, wealth tax and indirect taxes, such as value added tax (VAT), central sales tax (CST), customs duty, excise duties and service tax. Transaction taxes are set to witness a major change as India works towards implementing a goods and services tax (GST) across the country. State taxes include sales tax, profession tax and real estate taxes. Tax incentives focus mainly on establishing new industries, encouraging investments in undeveloped areas, infrastructure and promoting exports. Export and other foreign exchange earnings were previously favoured with income tax incentives, but these have generally been phased out except for predominantly export-oriented units set up in SEZs. The Special Economic Zones Act (2005) grants fiscal concessions for both SEZ developers and units in the SEZs and provides for a legislative framework in establishing offshore banking units and international financial service centres. Separate divisions of the Ministry of Finance administer the various national taxes. The Central Board of Direct Taxes administers direct taxes. A new Direct Tax Code (DTC) that will bring about significant structural changes to direct taxation in India was unveiled on 12 August 2009 to replace the Income Tax Act that dates from 1961. The DTC, which is expected to become effective on 1 April 2011, will consolidate and amend the law relating to income tax, dividend distribution tax, fringe benefit tax and wealth tax, and will create a system that facilitates voluntary compliance. The chart below summarizes the corporate tax changes in the DTC.
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Direct Tax Code Corporate tax rate
Reduced to 25% for both domestic and foreign companies with no levy or surcharge or cess. As a result, the effective rate will be 25%.
Branch tax rate
In addition to the 25% corporate income tax rate, foreign companies would be liable to a branch profits tax of 15% on branch profits (total income as reduced by corporate tax), regardless of whether the income is repatriated.
Minimum alternate tax
Companies would pay MAT at a rate of 2% of gross assets (0.25% for banks) rather than at a rate of 18% (plus any applicable surcharge and cess) of adjusted book profits of corporations whose tax liability is less than 18% of their book profits, with a credit available for MAT paid against tax payable on normal income, which may be carried forward for seven years. The MAT would be a final tax, thus eliminating the carryforward of MAT credits. MAT would continue to apply to both domestic and foreign companies.
Dividend distribution tax
Resident companies would be subject to DDT at a rate of 15% of dividends declared and dividends that have been subject to DDT would be exempt from tax in the hands of the recipient.
STT
The securities transaction tax would be eliminated.
Wealth tax
Companies would no longer be required to pay wealth tax. The rate payable by other entities would be reduced to 0.25% (currently 1%) and the threshold limit would be increased to INR 500 million (currently INR 3 million)
Withholding tax rate
Dividends - If dividends paid by a resident company are not liable to DDT, the payer would be required to withhold tax at a rate of 10% (20% for nonresident recipients unless reduced by a tax treaty). No surcharges or cess would apply. Interest and royalties - The withholding tax rate will be 10% (20% for nonresidents unless reduced by a tax treaty) and no surcharges or cess would apply. “Other payments” - A 10% withholding tax rate (35% for nonresidents unless reduced by a tax treaty) would apply on any other payments not specifically mentioned in the DTC. No levy of surcharges or cess would apply.
Treaty override
The later of a treaty’s provisions or the domestic law would prevail.
“Domestic company”
A “domestic company” will be defined as a company that is resident in India, i.e. if it is incorporated in India or management and control of its affairs are wholly or partly in India at any time in the financial year.
Losses
Losses would be able to be carried forward indefinitely.
Depreciation
The scope of “intangible assets” would be expanded to include prescribed preliminary expenses (at 25%) and expenditure on any asset or project constructed, erected or otherwise set up by the assessee where the benefit or advantage arises to the assessee but the asset is not owned by the assessee (at a rate of 20% if the benefit period does not exceed 10 years, 15% if it does). Depreciation also would be allowed on certain deferred revenue expenditure such as non-compete fees (25%), premiums for obtaining any asset on lease or rent (25%), amounts paid to an employee in connection with his/her retirement under any voluntary retirement scheme (25%), expenditure incurred by an Indian company on a business reorganization (25%), and, to the extent prescribed, expenditure incurred by a person resident in India wholly and exclusively 10
Direct Tax Code on any operations relating to prospecting for any mineral or the development of a mine or other natural deposit of any mineral (15%). Capital gains
Income from the transfer of any investment asset (except for personal effects and agricultural land) would be subject to tax as capital gains. The distinction between a short and long-term investment asset would be eliminated. The base date for determining the acquisition cost for computing capital gains would shift from 1 April 1981 to 1 April 2000. Further, any gain (long- or short-term) arising on transfer of an investment asset would be included in the assessee’s total income, chargeable to tax at the applicable rate bracket. Gains from the transfer of shares of a nonresident company (NRC) from one NRC to another if the NRC having its shares transferred indirectly holds a “controlling interest” in an Indian company would be subject to tax.
Incentives
All but a few of the tax exemptions presently available would be eliminated and replaced with investment linked incentives.
Related party transactions
The current threshold limits for two enterprises to be classified as associated enterprises would be reduced. Advance pricing agreements and safe harbour rules would be introduced.
Returns
The tax return filing date would be 30 June following the financial year for non-business, non-corporate taxpayers and 31 August following the financial year for all other taxpayers.
Penalties
The amount of penalty would be 100%-200% of the amount of tax payable in respect of the amount by which the tax base is underreported. This amount of tax payable would be calculated at the maximum marginal rate and no income tax authority would have the authority to waive the penalty.
5.2 Taxable income and rates Corporate entities liable for income tax include Indian companies and corporate entities incorporated abroad. A company is considered resident in India if it is incorporated in India, if control and management of its affairs take place in India or if the company has made prescribed arrangements for the declaration and payment in India of dividends payable out of income liable to tax under the Income Tax Act (1961). A resident company is liable for income tax on its worldwide profits, including capital gains, less allowable deductions (essentially, outlays incurred exclusively for business purposes). A nonresident company is liable for income tax on income arising in or received in India or deemed to arise or accrue in India. Income that is deemed to accrue or arise in India includes:
Income arising from a “business connection,” property, asset or source of income in India;
Capital gains from the transfer of capital assets situated in India; and
Interest, royalties and fees for technical services paid by an Indian resident, nonresident or the Indian government (Finance Bill, 2010 includes a proposal to change the source rules so that payments made to nonresidents for the provision of services – even services rendered outside the country – would be taxable in India).
Different rates apply to resident and nonresident companies. The corporate tax rate for domestic companies is 30%, along with a surcharge of 10% (proposed to decrease to 7.5% for domestic companies as from 1 April 2010 under the 2010/2011 budget), where the total income exceeds INR 10 million. In addition, a 2% education cess and 1% secondary and higher education cess (collectively referred to as “cess”) 11
is levied on the amount of income tax including the surcharge. The effective tax rate for domestic companies is therefore 30.9% (where income is less than or equal to INR 10 million) and 33.99% (where income exceeds INR 10 million). Nonresident companies and branches of foreign companies are taxed at a rate of 40%, plus a surcharge of 2.5%, where total income exceeds INR 10 million. The amount of tax is further increased by a cess of 3%, bringing the effective tax rate to 42.23% (where income exceeds INR 10 million) and 41.2% (where income is less than or equal to INR 10 million). The taxable income of nonresident companies engaged in certain businesses (i.e. prospecting for, extraction or production of mineral oils, civil construction, testing and commissioning of plant and machinery in connection with turnkey power projects) is deemed to be 10% of the specified amounts. Similarly, for nonresidents in the business of operating ships and aircraft, profits and gains from the operations are deemed to be 7.5% and 5%, respectively, of the specified amounts. A minimum alternate tax (MAT) is imposed on both resident and nonresident corporations. Under the MAT provisions, where the income tax payable on the total income by a company is less than 18% of its book profits, the book profits are deemed to be the total income of the company on which tax is payable at the rate of 18%, further increased by the applicable surcharge and cess. Thus, the effective MAT rate for a domestic company is 18.45% where the total income is less than or equal to INR 10 million, and 20.394% where the total income exceeds INR 10 million (rates comprise the base rate of 18%, plus the applicable surcharge of 10% and cess of 3%). For nonresident companies, the effective MAT rate is 18.54% where the total income is less than or equal to INR 10 million, and 19.0035% where the total income exceeds INR 10 million (rates comprise the base rate of 18%, plus the applicable surcharge of 2.5% and the 3% cess). Tax paid under the MAT provisions may be carried forward to be set off against income tax payable in the next 10 years, subject to certain conditions. Further, a domestic company is required to pay DDT of 15% (plus a surcharge of 10%) on any amounts declared, distributed or paid as dividends. After adding the 3% cess, the effective DDT rate is 16.995%. However, the ultimate Indian holding company is allowed to set off the dividends received from its Indian subsidiary against dividends distributed in computing the DDT tax provided certain conditions are satisfied. Dividends paid to the New Pension Scheme Trust are exempt from DDT. Taxable income defined The law divides taxable income into various categories or “heads.” The heads of income relevant to companies are:
Business or professional income;
Capital gains;
Income from real estate; and
Other income.
In general, a company’s taxable income is determined by aggregating the income from all of the heads. The computation of business income is normally based on the profits shown in the financial statements, after adjusting for exempt income, non-deductible expenditure, special deductions and unabsorbed losses and depreciation. Dividends paid by a domestic company are exempt from tax in the hands of the recipient provided DDT has been paid by the distributing company, but dividends on which DDT has not been paid are taxed as income in the hands of the recipient at the normal rates. Deductions In computing taxable income, various deductions are taken into account and each head of income has its own special rules. Allowable deductions include wages, salaries, reasonable bonuses and commissions, rent, repairs, insurance, royalty payments, interest, lease payments, certain taxes (sales, municipal, road, property and expenditure taxes and customs duties), depreciation, expenditure for materials, expenditure for scientific research and contributions to scientific research associations and professional fees for tax services. 12
Specific deductions are allowed as follows:
A 100% deduction for interest payments on capital borrowed for business purposes. However, if the capital is borrowed for the acquisition of an asset for the expansion of an existing business or profession, interest paid for any period beginning from the date on which the capital was borrowed for the acquisition of the asset up to the date the asset was first put into use is not allowable as a deduction;
Capital expenditure on research conducted in-house (this can rise to 150% (proposed 200% for FY 2010/11)) and for payments made for scientific research to specified companies or specified organisations (125% (proposed 175% for FY 2010/11) for payments to a national government laboratory, certain educational institutions and certain approved research programmes);
Investment-linked incentives (a 100% deduction for capital expenditure other than expenditure incurred on the acquisition of land, goodwill or financial instruments) for setting up and operating cold chain facilities, warehousing and laying and operating cross-country natural gas or crude or petroleum oil pipeline networks for distribution, including storage facilities that are an integral part of such networks;
Interest, royalties and fees for technical services paid outside India to overseas affiliates or in India to a nonresident provided tax is withheld;
Payments to employees under voluntary retirement schemes may be deducted over five years. To encourage companies to employ additional workers, an amount equal to 30% of additional wages paid to new employees is allowed as a deduction for three years subject to certain conditions;
Securities transaction tax paid; and
Business losses (see below).
Indian tax law does not permit companies to take a deduction for a general bad debt reserve, although specific bad debts may be deducted when written off. Expenses incurred for raising share capital are not deductible, as the expenditure is considered capital in nature. No deduction is allowed for expenditure incurred on income that is not taxable or for payments incurred for purposes that are an offence or prohibited by law or that were subject to withholding tax by the payer and the withholding obligation has not been correctly administered. Indian branches of foreign corporations may only claim limited tax deductions for general administrative expenses incurred by the foreign head office. These may not exceed 5% of annual income or the actual payment of head office expenditure attributable to the Indian business during the year (unless otherwise provided for in an applicable tax treaty), whichever is lower. Depreciation Asset depreciation is usually calculated according to the declining-balance method (except for assets of an undertaking engaged in the generation or generation and distribution of power for which the straight-line method is optional). Depreciation is based on actual cost, i.e. the purchase price plus capital additions, including certain installation expenses. The depreciation rate on general plant and machinery is 15%. Subject to certain conditions, additional depreciation on new plant and machinery acquired on or after 1 April 2005 may be available at 20% of actual cost. Factory buildings may be depreciated at 10%; furniture and fittings at 10%; computers and software at 60%; specified energy-saving devices at 80%; and specified environmental protection equipment at 100%. Depreciation is allowed at 100% for buildings acquired after 1 September 2002 for the installation of machinery or plant, but only for water supply projects or water treatment systems put to use as infrastructure facilities. Depreciation is 50% of normal rates if an asset is used for less than 180 days in the first year. Depreciation allowances on buildings, machinery, factories and factory equipment or furniture, are also available on assets partly owned by a taxpayer. Unabsorbed depreciation may be carried forward indefinitely. 13
Capital assets purchased for scientific research may be written off in the year the expenditure is incurred. Preliminary outlays for project or feasibility reports (limited to 5% of the cost of the project or capital employed) may be amortised over five years from the commencement of business incurred after 31 March 1998 (2.5% over 10 years for expenses before that date). For succession in businesses and amalgamation of companies, depreciation is allowed to the predecessor and the successor, or the amalgamating and amalgamated company, according to the number of days they used the assets. If an asset has been sold and leased back, the actual cost for computing the depreciation allowance is the written-down value to the seller at the time of transfer. Certain types of intangible assets that have been acquired may be amortised at a rate of 25%. Losses Losses arising from business operations in an assessment year may be set off against income from any source in that year. A business loss may be carried forward and set off against future business profits in the next eight assessment years. Closely held companies must satisfy a 51% continuity of ownership test to qualify for business loss carryforward. Losses arising from the transfer of short-term capital assets during an assessment year may be set off against capital gains (whether long- or short-term) arising during the assessment year. The balance of losses, if any, may be carried forward to offset capital gains in the subsequent eight years. Long-term capital losses may be set off only against long-term gains during the year. The balance of losses, if any, may be carried forward for the subsequent eight assessment years to offset long-term capital gains. Losses may be carried forward only if the tax return is filed by the due date. However, unabsorbed depreciation can be carried forward indefinitely, even if the tax return is not filed by the due date. Business reorganisations Special provisions in the Income Tax Act make qualifying business reorganisations, such as amalgamations or demergers, tax-neutral provided specific conditions are satisfied. The transfer of a capital asset in an amalgamation by the amalgamating company to the amalgamated company is exempt from capital gains tax subject to certain conditions. In a cross-border situation, when a foreign holding company transfers its shareholding in an Indian company to another foreign company as a result of a qualifying amalgamation, the transfer of the capital assets is exempt from capital gains tax subject to certain conditions. In the case of a merger, the shareholders of the amalgamating company are allotted shares in the amalgamated company. Such relinquishment of shares of the amalgamating company held by the shareholders is not regarded as a transfer of shares and, subject to prescribed conditions, is exempt from capital gains tax. When the shares of the amalgamated company are transferred by the shareholder, the acquisition costs will be deemed to be the acquisition costs of the shares of the amalgamating company. Subject to satisfying certain conditions, business losses, as well as unabsorbed depreciation of an amalgamating company owning an industrial undertaking, ships, hotels, banking, telecommunications or information technology services company, may be carried forward by the amalgamated company. To set off and carry forward losses and unabsorbed depreciation, the amalgamated company must retain at least 75% of the book value of fixed assets of the absorbed unit and it must continue business of the amalgamating company for a minimum period of five years. The unit itself should have been engaged in the business for at least three years, during which time the loss or depreciation was accumulated, and should have held at least 75% of the book value of fixed assets for two consecutive years before the merger. Where an undertaking of an Indian company that is entitled to an exemption/deduction under the Income Tax Act is amalgamated, the benefit of the deduction/exemption is available to the amalgamated company. Under a demerger, all of the assets and liabilities of the demerging company are transferred to the resulting company, and in consideration, the resulting company issues its shares to the shareholders of the demerging company. Provided certain conditions are satisfied, the transfer 14
of assets by the demerged company to the resulting company is exempt from capital gains tax. To qualify for the exemption, the resulting company must be an Indian company. Where an undertaking of an Indian company that is entitled to exemption/deduction under the Indian Income Tax Act is demerged, the benefit of certain specified deductions/exemptions is available to the resulting company. Expenditure incurred by an Indian company for an amalgamation or demerger of an undertaking may be amortised over a five-year period. 5.3 Capital gains taxation Gains derived from the disposition of capital assets are subject to capital gains tax, the tax treatment of which depends on whether the gains are long- or short-term. The minimum holding period for long-term capital gains is three years, although this period is reduced to one year in the case of shares and specified securities/bonds and units of mutual funds. Short-term capital gains on listed shares and units of an equity-oriented mutual fund where STT is paid are taxed at a rate of 15% (plus the applicable surcharge and the 3% cess). Long-term capital gains (on listed shares and units of equity-oriented mutual funds held for at least one year) where STT is paid are exempt. Nonresidents pay capital gains tax on the sale of securities in an Indian company, based on the value of the securities in the foreign currency in which they were purchased. The capital gains are reconverted into rupees and taxed; no inflation index is applied. Long-term capital gains of FIIs on listed shares and units of equity-oriented mutual funds where STT is paid are exempt, and short-term capital gains on such assets where STT is paid are taxed at 15% plus the applicable surcharge and cess. Other long-term capital gains derived by FIIs (i.e. gains not arising from listed securities that are exempt as discussed above) are taxed at 10%, plus the applicable surcharge and cess. Other short-term capital gains derived by FIIs (i.e. gains not arising from listed securities referred to above) are taxed at 30%, plus the applicable surcharge and cess. Other long-term capital gains derived by residents and nonresidents (i.e. gains not arising from listed securities that are exempt as discussed above) are taxed at 20%, plus the applicable surcharge and cess. In calculating long-term gains, the costs of acquiring and improving the capital asset are linked to an inflation index published by the government. The holder of an asset purchased before 1 April 1981 may use the fair market value of the asset on that date as the cost basis for computing the capital gain. This generally reduces tax liability. Other short-term capital gains derived by residents and nonresidents (i.e. gains not arising from listed securities referred to above) are taxed at normal rates, plus the applicable surcharge and cess. Gains from the sale of long-term capital assets are exempt from capital gains tax if they are reinvested in certain securities (subject to an annual cap of INR 5 million) within six months and locked in for three years. 5.4 Withholding tax Dividends Dividends are generally exempt and not subject to withholding tax. However, the company paying the dividends is subject to DDT at a rate of 15%, plus the applicable surcharge and cess. Interest Interest paid is generally subject to a 20% withholding tax, plus the applicable surcharge and cess (2.5% surcharge if payment exceeds INR 10 million and 3% cess, for a withholding rate of 20.6% or 21.115%). The rates may be reduced by treaty.
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Royalties and fees for technical services The withholding tax on royalties and fees for technical services is 10% unless reduced by treaty. Additionally, a surcharge (2.5% if the payment exceeds INR 10 million) and cess (3%) are imposed, increasing the withholding tax to 10.3% or 10.5575%. Other All companies must withhold tax at a rate of 40% plus a surcharge (2.5% if the payment exceeds INR 10 million) and cess (3%) from payments to nonresident contractor companies and 30% plus a surcharge (2.5% if the payment exceeds INR 10 million) and cess (3%) in the case of individuals for carrying out any work under a contract or for supplying labour for carrying out such work, subject to satisfaction of certain conditions. 5.5 Foreign income and tax treaties A resident of India that derives income from a non-tax treaty country is eligible for a credit for the foreign income taxes paid. The credit is granted on a country-by-country basis and is limited to the lesser of the income from the foreign country concerned or the foreign income tax paid on the income. Most of India’s treaties grant relief from double taxation by the credit method or by a combination of the credit and exemption methods. India has a comprehensive tax treaty network in force with many countries. There are also agreements limited to aircraft profits and shipping profits. The table below sets out the withholding tax rates in India’s tax treaties; the domestic rate (D) applies if it is lower. Withholding tax rates under India’s tax treaties (%) Dividends(1)
Interest(2)
Royalties
Armenia
10
10
10
Australia
15
15
10/15
Austria
10
10
10
Azerbaijan(3)
15
15
15/20
Bangladesh
10/15
10
10
Belarus
10/15
10
15
Belgium
15
10/15
10
Botswana
7.5/10
10
10
Brazil
15
15
15/25
Bulgaria
15
15
15/20
Canada
15/25
15
10/15
China
10
10
10
Cyprus
10/15
10
10/15
10
10
10
15/25
10/15
20
D
D
D
Treaty Partner
Czech Republic Denmark Egypt
16
Withholding tax rates under India’s tax treaties (%) Treaty Partner
Dividends(1)
Interest(2)
Royalties
Faroe Islands
15/25
10/15
20
Finland
0/15
10
10/15
France
10
10
10
Georgia(3)
15
15
15/20
Germany
10
10
10
Greece
D
D
D
Hungary
10
10
10
Iceland
10
10
10
10/15
10
15
Ireland
10
10
10
Israel
10
10
10
Italy
15/25
15
20
Japan
10
10
10
Jordan
10
10
20
Kazakhstan
10
10
10
Kenya
15
15
20
15/20
10/15
15
Kuwait
10
10
10
Kyrgyzstan
10
10
15
Libya
D
D
D
Luxembourg
10
10
10
Malaysia
10
10
10
Malta
10/15
10
15
Mauritius
5/15
D
15
Moldova(3)
15
15
15/20
Mongolia
15
15
15
Morocco
10
10
10
Myanmar
5
10
10
Namibia
10
10
10
Indonesia
Korea (R.O.K.)
17
Withholding tax rates under India’s tax treaties (%) Dividends(1)
Interest(2)
Royalties
10/15
10/15
15
Netherlands
10
10
10
New Zealand
15
10
10
Norway
15/25
15
10
Oman
10/12.5
10
15
Philippines
15/20
10/15
15
Poland
15
15
22.5
Portugal
10/15
10
10
Qatar
5/10
10
10
Romania
15/20
15
22.5
Russia
10
10
10
Saudi Arabia
5
10
10
Serbia
5/15
10
10
Singapore
10/15
10/15
10
Slovakia(4)
15/25
15
30
Slovenia
5/15
10
10
South Africa
10
10
10
Spain
15
15
10
Sri Lanka
15
10
10
Sudan
10
10
10
Sweden
10
10
10
Switzerland
10
10
10
Syria
5/10
10
10
Tajikistan
5/10
10
10
Tanzania
10/15
12.5
20
Thailand
15/20
10/25
15
Trinidad and Tobago
10
10
10
Turkey
15
10/15
15
Turkmenistan
10
10
10
Treaty Partner Nepal
18
Withholding tax rates under India’s tax treaties (%) Dividends(1)
Interest(2)
Royalties
Uganda
10
10
10
Ukraine
10/15
10
10
United Arab Emirates
10
5/12.5
10
United Kingdom
0/15
10/15
10/15
United States
15/25
10/15
10/15
Uzbekistan
15
15
15
Vietnam
10
10
10
Zambia
5/15
10
10
Treaty Partner
(1) Dividends declared by an Indian company are subject to DDT of 16.995%, but no withholding tax is levied. (2) Interest earned by the government and certain institutions are generally exempt from taxation in the source country. (3) The treaty with the former Soviet Union continues to apply. (4) The treaty with the former Czechoslovakia continues to apply. 5.6 Transactions between related parties Transfer pricing The transfer pricing regulations are broadly based on the OECD Guidelines, with some differences (and more stringent penalties). Definitions are provided for “international transaction,” “associated enterprise” and “arm’s length price.” The definition of associated enterprise extends beyond shareholding or management relationships, as it includes some deeming clauses. The arm’s length principle is enforced by determining an arm’s length price for an international transaction, and allowing a deviation of the arm’s length price to be within 5% of the price of the international transaction. The transfer pricing rules require the assessee to maintain documentation and obtain a certificate (in a prescribed format) from a chartered accountant furnishing the details of international transactions with associated enterprises, along with the methods applied for benchmarking. Where the application of the arm’s length price would reduce the income chargeable to tax in India or increase the loss, no adjustment is made to the income or loss. If an adjustment is made to a company enjoying a tax holiday, the benefit of the holiday will be denied in relation to the adjustment made. Transfer pricing audits have been aggressive and a subject of substantial controversy and litigation in recent years. Several measures, such as the introduction of a Dispute Resolution Panel, additional resources to handle transfer pricing audits and extension of the timeline for completing the audit have been introduced to reduce the burden of the audits on the tax officers and make the audit process more “reasonable” so that the results are evaluated under the facts and circumstances of each taxpayer. Thin capitalisation rules India does not have thin capitalisation rules. Controlled foreign companies India does not have CFC rules. Group taxation No provision is made for group taxation or group treatment; all entities are taxed separately.
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5.7 Turnover and other indirect taxes and duties VAT All Indian states, including union territories, have moved to the VAT regime - a broad-based “consumption-type destination-based VAT” driven by the invoice tax credit method that applies to almost all types of movable goods and specified intangible goods, barring a few exempted goods that vary from state to state. The tax paid on specified inputs procured within any state involved in the manufacturing of goods for sale within the state or for interstate sale and the input tax on specified goods purchased within the state by a trader (in both cases from registered dealers) are available as VAT credits, which may be adjusted against the tax on output sales within the state or the tax on interstate sale. The standard VAT rate is 12.5%, with lower rates of 4% and 1%. Certain states have increased these floor rates for sales within the states. The reduced rates apply to the sale of agricultural and industrial inputs, capital goods and medicines, precious metals, etc. A refund of input tax is available for exporters. Registration is compulsory for businesses exceeding prescribed turnover threshold limits that vary across states. Most states prescribe the threshold limit of annual turnover of INR 500,000 for compulsory VAT registration, although certain state VAT laws also specify monetary limits of sales and/or purchases. VAT returns and payments are either monthly or quarterly based on the quantum of tax liability. Central sales tax The central government levies CST on the interstate movement of goods, but the tax is collected and retained by the origin state. CST is levied at a rate of 2% on the movement of such goods from one state to another provided specified forms are submitted. If such specified forms are not submitted, then CST is charged at the higher of the CST rate or applicable local VAT rate of the state from where the goods are being sold. Registration is compulsory for all dealers engaging in interstate sales or purchase transactions liable to CST. CST returns and payments are monthly or quarterly based on the period applicable for filing the return/payment of tax in the state in which CST is required to be paid. CST paid on interstate purchases is not allowed as a set off or as a credit against VAT/CST payable in any state. Stock transfers of goods between states also are subject to retention of the input tax credit up to specified percentages (ranging from 2% to 4% of the purchase value of respective goods) in the state from which the goods are stock transferred. Customs duties Customs duties are levied by the central government generally on the import of goods into India, although certain exported goods also are liable to customs duties. The basis of valuation in respect of imports and exports is the transaction value, except where the value is not available or has to be established because of the relationship between the parties. The peak rate of basic customs duty is 10%. However, the aggregate customs duties, including additional duties and the education cess, is 26.85%. Several products attract the basic customs duty of 7.5%, which works out to an effective duty of 23.89%. The rates vary depending on the classification of the goods under the Customs Tariff Act, 1975. Safeguard and anti-dumping duties are also levied on specified goods. Central excise duty A central excise duty is levied by the central government on the production or manufacture of goods in India. Liability for paying duty is on the producer or manufacturer. Excise duty rates are based on the transaction value, except where such value is not available or has to be otherwise established. The standard excise duty rate is 10.3%, including education cess. The rates vary depending on the classification of goods under Central Excise Tariff Act, 1985. Service tax Service tax is levied at 10.30% of the value of taxable services (including the education cess and the secondary and higher education cess) on a broad range of services. Currently, over 110 services are subject to service tax, including advertising, brokering, business auxiliary, business 20
support, information technology software, supply of tangible goods, banking and financial consulting, construction, credit rating, management consulting, financial leasing, franchise services, credit card services, merchant banking, cargo handling, cable operation, storage and warehousing, intellectual property services, renting of commercial property and works contract services. Service providers having aggregate value of taxable services up to Rs. 1 Million are kept outside the purview of service tax, subject to certain conditions. 5.8 Other taxes The following taxes have been abolished:
The commodities transaction tax was abolished as from assessment year 2009-10;
The banking cash transaction tax does not apply in respect of taxable banking transactions entered into on or after 1 April 2009.
The fringe benefits tax (FBT) is abolished from assessment year 2010-11, so that all employee-related items on which the company was paying FBT are now taxable in the hands of the employee.
Securities transaction tax STT is levied on the purchase or sale of an equity share, derivative or unit of an equity-oriented fund entered in a recognised stock exchange in India at the following rates:
0.025% paid by the seller on the sale of an equity share or unit of an equity oriented fund that is non-delivery-based;
0.017% paid by the seller on the sale of an option and futures in securities;
0.125% paid by the buyer on the sale of an option in securities, where the option is exercised; and
0.125% each paid by the buyer/seller on the purchase/sale of an equity share or unit of an equity-oriented fund that is delivery-based.
STT paid in respect of taxable securities transactions entered into in the course of business is allowed as a deduction if income from the transactions is included in business income. Wealth tax Wealth tax is levied on specified assets and on specified categories of persons. The wealth tax is 1% on the aggregate value of specified assets (net of debt secured on, or incurred in relation to, the assets). The wealth tax applies to specified assets exceeding INR 3 million. Stamp duty Amongst other taxes, a tax is also levied in the form of stamp duty on instruments recording certain transactions. Stamp duty rates depend upon the nature of instrument and whether the instrument is to be stamped under the Indian Stamp Act, 1899 or under a state stamp law. Stamp duty rates for an instrument may vary by state. Real estate duty Owners of real estate are liable to various taxes imposed by the state and municipal authorities. These taxes vary by state. R&D Cess The R&D Cess Act (1986) provides for a cess of 5% on all payments made for the import of “technology.” A credit mechanism to offset the cess may be available in certain situations upon the fulfilment of certain requirements.
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Social security contributions Employers are required to make social security contributions for their employees (see 7.2. below). 5.9 Tax compliance and administration The tax year in India, known as the “previous year” (fiscal year), is the year beginning 1 April and ending 31 March. Income tax is levied for a previous year at the rates prescribed for that year. Income of a fiscal year is assessed to tax in the next fiscal year (i.e. assessment year). Taxes on income of an assessment year are usually paid in instalments by way of advance tax. A company must make a prepayment of its income tax liabilities by 15 June (15% of total tax payable), 15 September (45%), 15 December (75%) and 15 March (100%). Any overpaid amount is refunded after submission of the final tax return. A company must file a final tax return, reporting income of the previous year, by 30 September immediately following the end of the fiscal year, stating income, expenses, taxes paid and taxes due for the preceding tax year. A non-corporate taxpayer that is required to have its accounts audited also must file a return by 30 September. All other assessees must submit returns by 31 July. Guidance is issued annually for the selection of tax returns for scrutiny by the tax authorities. If the tax authorities can prove concealment of income, a 100%–300% penalty may be levied on the tax evaded. All taxpayers are required to apply for a permanent account number (PAN) for purposes of identification. The PAN must be quoted on all tax returns and correspondence with the tax authorities and on all documents relating to certain transactions. As from 1 April 2010, every recipient (whether resident or nonresident) of India-source income subject to withholding tax must furnish a PAN to the Indian payer before payment is made. Otherwise, tax will have to be withheld at the higher rate as prescribed. The Authority for Advance Rulings issues rulings on the tax consequences of transactions or proposed transactions with nonresidents. Rulings are binding on the applicant and the tax authorities for the specific transaction(s).
6.0 Personal taxation As noted above, a new DTC that will bring about significant structural changes to direct taxation in India was unveiled on 12 August 2009 to replace the Income Tax Act 1961. The DTC, which is expected to become effective on 1 April 2011, will consolidate and amend the law relating to income tax, dividend distribution tax, fringe benefit tax and wealth tax, and will create a system that facilitates voluntary compliance. The chart below summarizes the personal tax changes in the DTC.
Direct Tax Code Residence
The concept of “resident and not ordinarily resident” would be abolished.
Basis
Residents would not be taxed on income accrued/received outside India if the income relates to: (1) the financial year in which the individual ceases to be a nonresident; or (2) the financial year immediately succeeding that financial year, provided the individual was a nonresident for nine years immediately preceding the financial year in which he/she ceased to be a nonresident.
Exemptions and deductions
Several exemptions currently available under income from salaries would be eliminated, such as the house rent allowance, the leave travel allowance and leave encashment. Also eliminated would be the current deduction of interest up to INR 150,000 for self-occupied property. 22
Direct Tax Code
An individual or a Hindu Undivided Family would be allowed a deduction (not to exceed INR 300,000) in respect of: amounts deposited in an account maintained with any permitted savings intermediary and expenses incurred in respect of eligible tuition fees (including play school or preschool). Eligible tuition fees are currently capped at INR 100,000. Current deduction rules would be modified to provide that: interest on a loan obtained from an approved charitable institution would not be regarded as interest on a loan taken for higher education; no deductions would be available for the medical treatment of the taxpayer’s dependant siblings; and the exemption currently available for medical reimbursements up to INR 15,000 would be eliminated. Tax brackets
The brackets for individual tax rates would be broadened. The basic exemption limit would remain unchanged, leaving the first INR 160,000 exempt. Higher basic exemptions would remain static for female residents under the age of 65 (INR 190,000) and resident senior citizens (INR 240,000). The 10% bracket (exclusive of surcharge) would be INR 160,001 to INR 1 million (from INR 500,000 under Finance Bill, 2010); the 20% bracket would be INR 1,000,001 to INR 2.5 million (from outer limit of this range of INR 800,000 under Finance Bill, 2010); the 30% rate would apply to amounts in excess of INR 2.5 million (from INR 800,000 under Finance Bill, 2010). While the current maximum marginal rate is 30.9% due to the applicable 3% cess, the proposed maximum marginal rate is 30%.
Treaty benefits
A certificate of residence would be required to claim treaty benefits. India also would not provide a credit for taxes paid overseas in respect of Indiasource income if there is no treaty in place. The treaty override where the treaty provisions are more beneficial would be eliminated, with the later of the DTC or the treaty prevailing.
Wealth tax
Net wealth in excess of INR 500 million (currently INR 3 million) would be chargeable to wealth tax at the rate of 0.25% (currently 1%). For nonresidents who also are not Indian citizens, the value of assets located outside India would not be chargeable to wealth tax. The definition of “wealth” would extended to include all assets other than specific exclusions, such as one house, or part of the house or plot belonging to the individual that was acquired or constructed before the first day of April 2000. Finally, the value of the assets will be as per prescribed rules (except for cash).
6.1 Residency The extent of an individual’s liability for personal income tax depends on whether the individual is resident and ordinarily resident, resident but not ordinarily resident, or nonresident in India. For tax purposes, an individual is resident in India if he/she is physically present for at least 182 days in the country in a given year, or 60 days in a given year and 365 days or more in the preceding four years. Indian citizens leaving India for employment or as members of the crew of an Indian ship and for an Indian citizen/person of Indian origin working abroad who visits India while on vacation, the threshold is 182 days in the given year instead of 60 days. A “not ordinarily resident” individual is one who has either not been a resident in nine out of the 10 preceding years or who has been in India for 729 days or less during the preceding seven years. As a result, expatriate managers who have lived in India continuously for two years may be liable to tax on their foreign income in the third or fourth year.
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6.2 Taxable income and rates As in the case of companies, an individual’s income is divided into “heads.” These heads are: employment income, business or professional income, income from real estate, capital gains and other income. Personal income tax is levied on only about 3.5% of India’s more than one billion citizens. The personal tax rate is imposed at progressive rates of up to 30% (not including education surcharges totalling 3% that are levied on tax payable). A general exemption from tax and filing obligations applies for those with an income of less than INR 160,000, INR 190,000 for resident female taxpayers below 65 years of age and INR 240,000 for resident senior citizens. The vast majority of citizens are not liable for personal income tax. Finance Bill, 2010, which will apply retroactively from 1 April 2010, will leave the basic exemptions in place and broaden the remaining brackets: the 10% bracket (exclusive of surcharges) will be INR 160,001 to INR 500,000 (previously INR 300,000), the 20% bracket will be INR 500,001 to INR 800,000 (previously 500,000) and the 30% bracket (exclusive of surcharges) will apply to amounts in excess of INR 800,000 (previously INR 500,000).) Tax on long-term capital gains earned by individuals is generally 20% (plus the applicable education cess totalling 3%), except for gains on listed securities, which are exempt. The states levy a profession tax on salaried employees and persons carrying on a profession or trade at rates that vary by state. Determination of taxable income Residents of India are normally taxed on worldwide income. Persons not ordinarily resident generally do not pay tax on income earned outside India unless it is derived from a business/profession controlled in India, or the income is accrued or first received in India or is deemed to have accrued in India. For example, a pension for years of service in India—even if received abroad—is deemed to have accrued in India and is taxable. Nonresidents are liable to tax on Indian-source income, including: (1) interest, royalties and fees for technical services paid by an Indian resident; (2) salaries paid for services rendered in India; and (3) income that arises from a business connection or property in India. Standard deductions are not allowed. Allowed deductions include contributions to life insurance; recognised provident funds; national savings certificates; the national savings scheme; subscriptions to certain mutual funds; deposits made under Senior Citizen Savings Scheme Rules (2004); five-year time deposits under the Post Office Time Deposit Rules (1981); certain educational expenses up to INR 100,000; interest on loans for higher education (self, spouse and children) without limit; mortgage interest up to INR 150,000 annually on home loans obtained on or after 1 April 1999 if the borrower resides in the home; and royalties received by authors of literary, artistic and scientific books and for income from the exploitation of patents of up to INR 300,000. For perquisites provided by the employer, free or concessional accommodation will be valued at a specified percentage of the employee’s salary depending on the city where the accommodation is located; the use of movable assets (e.g. furniture) of the employer will be valued at 10% per annum of the actual cost of the assets or the amount of rent paid by the employer if the assets are leased (provision of computers and laptops is not treated as a perquisite, and interest-free or concessional loans exceeding INR 20,000 are presumed to carry interest calculated at the annual rate charged by the State Bank of India, depending on the purpose of the loan. However, contribution to an approved superannuation fund in excess of INR 100,000 is taxable as a perquisite; health-insurance premiums paid by the employer and reimbursement for medical expenses of up to INR 15,000 annually are tax-exempt; and up to INR 500,000 received from voluntary retirement schemes that conform to prescribed guidelines may be excluded from taxable income. The FBT was abolished with effect from 1 April 2009 and hence all employee-related items on which the company was paying FBT are now taxable in the hands of the employee.
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6.3 Special expatriate tax regime Remuneration received by foreign expatriates working in India generally is assessable under the head “salaries” and is deemed to be earned in India. Income payable for a leave period that is preceded and succeeded by services rendered in India and that forms part of the service contract is also regarded as income earned in India. Thus, irrespective of the residence status of an expatriate employee, the salary paid for services rendered in India is liable to tax in India. There are no special exemptions or deductions available to foreign nationals working in India, except for local living allowances, which are exempt to the extent the expense is actually incurred. However, a foreign national can make use of a short-stay exemption following the 90day threshold limit as prescribed under the Income Tax Act and the 183-day threshold limit under relevant tax treaties provided all applicable conditions are satisfied. Where salary is payable in a foreign currency, the salary income must be converted to Indian rupees. For this purpose, the rate of conversion to be applied is the telegraphic transfer-buying rate as adopted by the State Bank of India on the last day of the month immediately preceding the month in which the salary is due or paid. However, if tax is to be withheld on such an amount, the tax withheld is calculated after converting the salary payable into Indian currency at the rate applicable on the date tax was required to be withheld. 6.4 Capital taxes All individuals and other specified persons must pay a 1% wealth tax on the aggregate value of net wealth exceeding INR 3 million of non-productive assets such as land; buildings not used as factories; commercial property not used for business or profession; residential accommodation for employees earning over INR 500,000 per annum; gold, silver, platinum and other precious metals, gems and ornaments; and cars, aircraft and yachts. Municipalities levy property taxes (based on assessed value), and states levy land-revenue taxes.
7.0 Labour relations and workforce 7.1 Employees’ rights and remuneration India’s labour laws are complex, with more than 60 pieces of relevant legislation. Employers face particular difficulties in terminating employment and closing an industrial establishment. Working hours The Factories Act (1948) requires maximum working hours of 48 hours per week. In practice, however, office employees normally work a five-day week of 37-38 hours. Factory workers have on average a six-day week of 48 hours. Any work beyond nine hours per day or 48 hours per week requires payment of overtime at double the normal wage. Maternity leave of 12 weeks is provided under the Maternity Benefit Act (1961). 7.2 Wages and benefits Wages and fringe benefits vary considerably depending on the industry, company size and region. The floor level minimum wage is INR 100 per day and may be higher in certain industries. Wages generally have two components: the basic salary and the dearness allowance, which is linked to the cost-of-living index. The allowance, paid as part of the monthly salary, may be at a flat rate or on a scale graduated by income group. A mandatory bonus supplements wages. Companies use both time and piece rates. The former is more common in organised factory industries, such as engineering, chemicals, cement, paper, etc. Rates may be per hour, day, week or month. Piece rates, which the government has encouraged to boost productivity, are usually paid monthly, although casual workers are paid on a daily basis. Some industries pay production premiums.
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In the organised sector, wages are often set by settlements reached between trade unions and management. Statutory benefits, such as provident funds, pensions and bonuses, normally add 30%-42% to the base pay. Provident funds and pensions The Employees Provident Fund and Miscellaneous Provisions Act (1952) provides for provident funds and pension contributions for certain establishments engaging 20 or more employees. In practice, several industries are covered under the provident fund laws. Employers and employees contribute 10% or 12% (depending upon the type of industry) of wages (i.e. basic wages, dearness allowance and retaining allowance) per month. From the employer’s contribution, an amount up to INR 6,500 per annum (8.33% of wages) goes towards the pension fund, and the balance towards the provident fund. Employees contribute exclusively to the provident fund. Health and death benefits The Employees State Insurance Corporation provides health insurance for industrial workers, for which employers contribute 4.75% of an employee’s wages and employees contribute 1.75% on a monthly basis. The Workmen’s Compensation Act (1923) provides compensation for industrial accidents and occupational diseases resulting in disability and death. The minimum compensation payable by the employer is INR 80,000 for death and INR 90,000 for total disability. The maximum is INR 457,000 for death and INR 548,496 for total disability. Other benefits Share options are common in information technology, biotechnology, media, telecoms and banks. SEBI has issued the Employee Stock Option Scheme and Employee Stock Purchase Scheme Guidelines (1999), which are applicable to listed companies. Companies are permitted to freely price the stock options but are required to book the accounting value of options in their financial statements. The guidelines specify among others a one-year lock-in period, approval of shareholders by special resolution, formation of a compensation committee, accounting policies and disclosure in directors’ reports. Working conditions of employees The Industrial Employment (Standing Orders) Act (1946) requires industrial establishments with 100 (number may vary by state) or more employees to establish standing orders that specify working conditions (hours, shifts, annual leave, sick pay, termination rules, etc.). These orders must meet minimum state standards and may be changed only with the consent of the workers or the trade unions and only to augment benefits. 7.3 Termination of employment The Industrial Disputes Act (1947) requires industrial establishments with 100 (number may vary by state) or more employees to obtain government permission to close an operation. Employers must apply for permission at least 90 days before the intended closing date. If the government does not issue a decision within 60 days of the application, approval is deemed granted. An employer can apply to the relevant government agency to review their decision or appeal to the Industrial Tribunal. Workers in an establishment closed illegally (i.e. without approval) remain entitled to full pay and benefits. The employer may appeal against the labour court or tribunal order to a higher court and during the pendency of the appeal, the reinstated worker remains entitled to 100% of wages. Companies may use voluntary retirement schemes (VRSs) or redeployments. Beneficiaries under an approved VRS are exempt from tax on monetary benefits up to INR 500,000. Companies may amortise their VRS expenses over five years under tax laws. The Payment of Gratuity Act (1972) requires employers to pay a gratuity to workers who have rendered continuous service for at least five years at the time of retirement, resignation and superannuation at the rate of 15 days’ wages for every completed year of service or part thereof in excess of 6 months up to a maximum of INR 350,000. Gratuity is payable at the same rate in case of death or disablement of workers even though the worker has not completed five years of continuous service. 26
7.4 Labour-management relations With some exceptions, India has company unions rather than trade unions. These are often affiliated with national labour organisations. Various trade unions are promoted by political parties. In manufacturing and other companies, prior discussions between management and labour leaders often help to forestall strikes. When strikes or disputes occur, they are usually settled by negotiation or through conciliation boards. It is common practice in many foreign-owned manufacturing companies to avert strikes by employing a labour welfare officer to act as a gobetween for labour and management. By law, manufacturing companies with 500 or more workers must have one or more welfare officers who act as personnel manager, legal adviser on labour law and promote relations between factory management and workers. In nonunionised companies in certain states, workers’ representatives may be appointed to represent the workers. The Industrial Disputes Act (1947) requires industrial establishments with 100 or more workers to set up works committees consisting of representatives of employers and workers to promote measures for securing and preserving amity and good relations between the employer and workforce. Collective bargaining has gained ground in recent years, but agreements normally apply only at the plant level. Collective agreements have traditionally been the norm in banking; such pacts may last up to five years. At the central level, labour policies are managed jointly by the Indian Labour Conference and its executive body, the Standing Labour Committee, along with the various industrial committees. Representatives from the government, employers and labour are included in all three groups. 7.5 Employment of foreigners Expatriate employment in manufacturing industries is generally limited to technical and specialised personnel. Many foreign affiliates have a few expatriates in India. Permission from the RBI or the government is not required to employ a foreign national, but the Ministry of Home Affairs, which grants visas and certain specific appointments, may require government approval in some cases. Foreigners entering India on a student, employment, research or missionary visa that is valid for more than 180 days are required to register with the Foreigners Registration Officer under whose jurisdiction they propose to stay within 14 days of arrival in India, irrespective of their actual period of stay. Foreigners visiting India on any other category of long-term visa, including a business visa, that is valid for more than 180 days are not required to register if their actual stay does not exceed 180 days on each visit. If such a foreigner intends to stay in India for more than 180 days during a particular visit, he/she should register within 180 days of arrival in India. It normally takes about three months to obtain an immigration visa. The visa is generally granted for the same period as the employment contract. Once it is obtained, a stay permit is granted; this must be endorsed annually by the state government where the foreign national resides. Expatriates are often paid salaries several times more than those of their Indian counterparts. Domestic private sector salaries are rising quickly, although they vary widely among industries. The Ministry of Commerce and Industry has issued guidance clarifying that foreign nationals coming to India to execute projects or contracts are not covered under business visas and require employment visas.
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8.0 Office locations To find out how our professionals can help you in your part of the world, please contact us at the headquarters office listed below or through the “contact us” button on http://www.deloitte.com/tax. Deloitte Haskins & Sells 264-265 Vaswani Chambers Dr. Annie Besant Road Worli Mumbai 400 030
About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its Member Firms. Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanning multiple industries. With a globally connected network of member firms in 140 countries, Deloitte brings world class capabilities and deep local expertise to help clients succeed wherever they operate. Deloitte's 150,000 professionals are committed to becoming the standard of excellence. Deloitte's professionals are unified by a collaborative culture that fosters integrity, outstanding value to markets and clients, commitment to each other, and strength from diversity. They enjoy an environment of continuous learning, challenging experiences, and enriching career opportunities. Deloitte's professionals are dedicated to strengthening corporate responsibility, building public trust, and making a positive impact in their communities. This material has been prepared by professionals in the member firms of Deloitte Touche Tohmatsu. It is intended as a general guide only, and its application to specific situations will depend on the particular circumstances involved. Accordingly, we recommend that readers seek appropriate professional advice regarding any particular problems that they encounter. This information should not be relied upon as a substitute for such advice. While all reasonable attempts have been made to ensure that the information contained herein is accurate, Deloitte Touche Tohmatsu accepts no responsibility for any errors or omissions it may contain whether caused by negligence or otherwise, or for any losses, however caused, sustained by any person that relies upon it. © 2010 Deloitte Touche Tohmatsu. All rights reserved.
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