KPMG DTC Impact Power

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KPMG IN INDIA

KPMG Flash News1 September 2010

TAX

© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

All rights reserved.

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DIRECT TAX CODE BILL 2010 – IMPACT ON POWER SECTOR

BACKGROUND

In an attempt to simplify the direct tax provisions, the Government released

the Direct Taxes Code Bill, 2009 (DTC Bill 2009) in August 2009 for public

comments. The provisions of the DTC Bill 2009, especially the one relating

to MAT on gross assets, would have been a big dampener for the power

industry as it is a capital intensive industry. Several representations were

made by various stakeholders as well as Industry forums on the proposals

made in the DTC to remove the inconsistency as well as unintended

hardship. The Government appreciated the sentiments and made a historicalmove of issuing a Revised discussion paper in June 2010.

As a logical step post the Discussion Paper, the Government has now

presented the Direct Taxes Code Bill, 2010 (‘DTC’) before the Parliament.

The provisions of DTC are intended to come into effect from April 1, 2012

onwards. An analysis of the proposals in the DTC that are likely to impact

the Power sector is set out below.

KEY PROPOSALS AND THEIR IMPACT

Tax holiday to Power sector undertakings

Current situation :

Under the existing provisions of the Income-tax Act, 1961 (‘the Act’), profit

based deduction is available to undertaking set up for (‘Power sector

undertaking’) -

generation or generation and distribution of power, if it begins to

generate power before March 31, 2011

Reconstruction or revival of a power generating plant, if it begins to

generate or transmit or distribute power before March 31, 2011



DTC Proposals :

DTC has proposed to bring a paradigm shift in granting tax incentives to

undertakings engaged in business of generation, transmission or distribution of

power. The new scheme has proposed to substitute the profit-linked incentives

prevalent under the existing provisions of the Act with the expenditure /

investment based deductions. Further, it has provided for grandfathering of tax

holiday available to power units for the unexpired period.

Undertakings eligible for profit based deduction in Assessment Year 2012-13

Undertakings eligible for profit linked incentives under the Act for the

assessment year beginning on April 1, 2012 would be grandfathered under

DTC

While computing deduction, capital expenditure as well as expenditure

incurred prior to commencement of business shall not be allowed

The conditions specified under section 80IA for availing Tax Holiday shall

continue to be applicable

Undertaking set up in the DTC regime

profits shall be gross earning as reduced by business expenditure in

accordance with Schedule XIII of DTC

capital expenditure and expenditure incurred prior to commencement of

business shall be allowable as business expenditure, except expenditure

incurred on acquisition of any land including long term lease, goodwill or

financial instrument.

Comments :

Under the Act, undertaking which commences generation of power on or

before Mach 31, 2011 shall be eligible for profit linked incentives. The DTC

grandfathers those undertakings which are eligible to claim the exemption

under Act as on Assessment year 2012-13.

Accordingly, an issue arises as to whether an undertaking which commences

generaton of power during the period April 1, 2011 to March 31, 2012 will be

eligible for profit linked incentives and thus grandfathed under DTC. Though

the intention seems to provide the benefit to undertakings commencing

generation of power even beyond March 31, 2011, the same can be

implemented only on amendment in the Act. In view of this, this issue needs

to be suitably represented before the Ministry in the forthcoming budget.

It has been provided that the profit linked deduction under DTC shall be

computed as per the provisions of the DTC, but no capital expenditure would

be allowed. Accordingly, there is an ambiguity as to whether depreciation on

the WDV carried forward from the Act would be allowable under DTC and

thus would need to be adequately addressed




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The proposal to allow power companies to offset losses against profits of

other infrastructure projects or corporate income would be a welcome

measure

As such, continuation of these tax incentives to new power undertakings

under the DTC, though under a restrictive grandfathering clause, is still a

positive step. The grandfathering provisions would provide some relief to the

existing and new power undertakings.

Minimum Alternante Tax (MAT)

Current situation :

In light of the tax holiday available to the Power sector, MAT is a key provision

impacting the sector. Currently, MAT is applicable at the rate of 18% (effective

19.93% considering surcharge & cess) of the book-profits computed after

making specified adjustments to the net profit of the company. Further, the

companies are allowed to carry forward the MAT credit (which is the excess

of MAT tax paid over the tax computed in accordance with normal corporate

tax provisions) to future years.

DTC Proposals :

Under the Direct Tax Bill 2009, it was proposed that company shall pay tax on

its gross assets at the rate of 2 percent. (0.25% in case of banking

companies) if the tax liability is less than the tax on gross assets. The revised

draft of the DTC reintroduced profit based MAT .Under the DTC, the rate hasbeen increased from 18% to 20% of book profits.

Comments :

DTC Bill 2009 had proposed to levy MAT on the basis of gross assets, which

would had been a dampener for capital based industry like power. However,

DTC has brought back MAT to Book Profits which is a positive step towards

development of the power industry.

Corporate tax provisions – Key provisions

Tax rates

Current Situation :

Currently, the domestic companies are subject to corporate tax of 30% (plus

surcharge and education cess) on their taxable income




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DTC Proposals :

While the Direct Tax Code Bill, 2009 stipulated the corporate tax rate as 25%,

the Revised Discussion Paper had hinted that tax rates could be reviewed and

suitably calibrated considering the reduction in the tax base due to certain tax

benefits spelt out in the said paper.

The DTC now has retained the existing corporate tax rate of 30%.

Comments:

Maintaining the corporate tax rate at 30% is not a positive development, in as

much as other levies such as DDT of 15% and branch profit tax of 15% make

the effective tax rate quite high.

Test of Residency

Current Situation :

Under the provisions of the Act, a company is resident in India in any previous

year, if the control and management of its affairs is situated ‘wholly’ in India.

DTC Proposals :

Under DTC, it is proposed to shift the test of residence of a company from

‘control and management’ to ‘place of effective management’ in line with

international practice.

Accordingly, a company incorporated outside India will be resident in India, if its

‘place of effective management’ is situated in India.

Place of effective management of the company would mean:

Place where the board of directors or its executive directors make their

decisions

In cases where the board of directors routinely approve the commercial and

strategic decisions made by the executive directors or officers of the

company, the place where such executive directors or officers of the

company perform their functions.

Comments :

Although the concept of ‘place of effective management’ proposed under DTC

is in line with international practice, it is important that this provision is

administered in a fair and pragmatic manner. The new residency definition

could impact businesses where key decisions are taken by Indian management

/ executives and merely adopted by the board overseas.




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Treaty Override

Current Situation :

Under the Act, the provisions of the tax treaties prevail over the domestic law

to the extent they are more beneficial to the taxpayer.

DTC Proposals :

The initial draft of the Direct Tax Code Bill, 2009 provided that in the case of

a conflict between the provisions of a treaty and the provisions of the Code,

the one that is later in point of time shall prevail. This led to apprehensions

whether the proposal would lead to treaty override and render the existing

treaties otiose. Post the Revised Discussion Paper, the DTC seeks to

restore the beneficial treatment between the Act and the Tax Treaty except

in specified cases-

where GAAR is invoked or

when CFC provisions are invoked or

when Branch Profits Tax is levied

Comments :

The proposals seem to be in line with international practice.

Controlled Foreign Corporation (CFC) Provisions

Current Situation :

Under the Act, there are no CFC provisions.

DTC Proposals :

The introduction of the CFC provisions has come as a major surprise for

India Inc. The CFC provisions have been brought in as an anti-avoidance

measure. Under this, passive income earned by a foreign company

controlled directly or indirectly by a resident in India, and where such income

is not distributed to the shareholders, resulting in deferral of taxes shall be

deemed to have been distributed to the shareholders in India. The CFC

provisions are broadly summarized as under:

The total income of a Resident taxpayer to include income attributable to

a CFC which means a foreign company:

– that is a resident of a territory with lower rate of taxation (i.e. where

taxes paid are less than 50 percent of taxes on such profits as

computed under the DTC)

– whose shares are not listed on any stock exchange recognised by

such Territory




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– individually or collectively controlled by persons resident in India (through

capital, voting power, income, assets, dominant influence, decisive influence,

etc.)

– that is not engaged in active trade or business (i.e. it is not engaged in

commercial / industrial / financial undertakings through employees / personnel

or less than 50 percent of its income is of the nature of dividend, interest

income, income from house property, capital gains, royalty, sale of

goods/services to related parties, income from management, holding or

investment in securities/shareholdings, any other income under the head

income from residuary sources, etc.)

has specified income of such company exceeds INR 2.5 million

Tie breaker tests have been provided to determine the place of residence of a

controlled foreign company.

Scope of passive income also covers supply of goods / services to associated

enterprises.

Specific formula prescribed for computing income attributable to a CFC. Income

attributable to the CFC to be based on specified income. Specified income to be

based on the net profit as per the profit and loss account of the CFC, subject to

prescribed adjustments.

Comments :

CFC provisions are likely to bring additional complexity in the tax legislation and could

significantly impact Indian companies having outbound investment structures.

Specifically, CFC provisions could create cash flow problems for Indian companies

since they would be subject to tax without corresponding receipt of actual dividends.

This may necessitate a review of the existing overseas investment structure.

Exempt-Exempt-Taxable (EET) vs. Exempt-Exempt-Exempt (EEE) Regime for

Saving Schemes

Current Situation :

Under the Act, long-term saving schemes like Government Provident Fund (GPF),

Recognized Provident Fund (RPF), Public Provident Fund (PPF), Life Insurance etc.

are covered under the EEE method, wherein the contributions, accumulations /

accretions thereto and the withdrawals are exempt from tax.




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DTC Proposals :

All long-term retiral savings schemes moved to EEE regime as against EET

proposed earlier. Deduction in respect of investment in approved funds such as

Provident Fund, Superannuation Fund or Pension fund reduced to INR 100,000from INR 300,000. Receipts under a life insurance policy on death/maturity

would be exempt from tax.

Comments :

The continuation of EEE regime is a welcome step as it will provide a tax free

lumpsum amount to individuals to meet their post-retirement financial

requirements.

Withholding tax provisions – Others

Current Situation :

The withholding tax rate on royalty and fees for technical services payable to

non-residents is 10% (excluding surcharge and education cess).

DTC Proposals :

The withholding tax rate in respect of payment of royalties and FTS to non-

residents is proposed to be increased to 20%.

Comments :

The higher withholding tax rates would increase the overall cost of the Indiancompanies in case of payments to tax residents of the country with whom India

does not have a Tax Treaty and grossing up of tax is required in case of tax is

borne Indian company.

Transfer Pricing

Current Situation :

Currently, there are no provisions under the Act in respect of Advance Pricing

Arrangement (‘APA’).

DTC Proposals :

It is proposed to introduce APA for upfront determination of pricing methodology

of an international transaction.




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Comments :

Whilst the scheme specifying the procedure of APA has not yet been released, theindustry would expect that the same is in line with the international practice.

Leased Assets

Current Situation :

In the absence of any specific provision under the Act, there is a lack of clarity

surrounding the treatment of assets obtained on finance lease by Power sector

undertakings. In certain cases, companies are facing litigation from revenue

authorities on the question of whether they are eligible to claim depreciation on

such assets.

DTC Proposals :

Under DTC, the lessee would be treated as the owner of assets obtained on

finance lease and therefore, eligible to claim depreciation on the same.

Comments:

This is an important provision for the companies in Power sector and it will help to

end the long drawn litigation regarding ‘ownership’ of such assets & depreciation

eligibility with the Revenue authorities.

General Anti Avoidance Rule (‘GAAR’)

Current Situation:

Under the Act, there are limited specific anti-abuse provisions.

DTC Proposals

The Code seeks to introduce GAAR which provides sweeping powers to the

Revenue authorities. The same is applicable to domestic as well as

international arrangements.




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GAAR provisions empower the Commissioner of Income-tax (“CIT”) to

declare any arrangement as “impermissible avoidance arrangement”

provided the same has been entered into with the objective of obtaining

tax benefit and satisfies any one of the following conditions :

– It is not at arm’s length

– It represents misuse or abuse of the provisions of the DTC

– It lacks commercial substance

– It is carried out in a manner not normally employed for bona fide

business purposes

An arrangement would be presumed to be for obtaining tax benefit

unless the tax payer demonstrates that obtaining tax benefit was not the

main objective of the arrangement.

CIT to determine the tax consequences on invoking GAAR byreallocating the income or disregarding/recharacterising the

arrangement.

Meaning of ‘tax benefit’ widened to include any reduction in tax bases

including increase in loss.

GAAR provisions to be applicable as per the guidelines to be framed by

the Central Government.

GAAR shall override Tax Treaty provisions.

Forum of DRP available in a scenario where GAAR is invoked.

Comments :

The guidelines to be issued by the Central Government would need careful

examination to assess the scope and impact of these provisions. It is an

open question whether GAAR can be invoked for transactions undertaken

prior to the enactment of DTC. A suitable clarification may be provided for

this purpose.

Concluding Remarks

Undoubtedly, the DTC has done more good to the power industry, for

instance, relief by way of grandfathering clause and removal of MAT based

on Gross assets, there are certain provisions where further clarity would be

required. for e.g. DTC has no specific provision for grandfathering of

unutilized MAT credit available under the Act.

In summary, the provisions of the DTC are expected to provide fillip to the

growth of the Indian infrastructure sector which is very crucial for the overall

growth of Indian economy.




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© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member f irms affiliated with

KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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affiliated with KPMG International Cooperative (“KPMG

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Documents

KPMG DTC Impact Power