Union Budget 2020: Tax Reforms Or Mere Amendments

With one of the longest ever Budget speech, the Finance Minister Nirmala Sitharaman presented the first Union budget of the decade. In the backdrop of a continuing economic slowdown and high expectations from the industry & individual taxpayers, the FM promised to continue on the agenda of reforms. While she proposed a number of measures to increase disposable income & boost sentiment, the fact that INR 3.46 lakh crore of investor wealth was wiped on Budget day was a clear indicator of investor reaction. Budget 2020 has proposed over 100 amendments to the Income-tax law, highlighted here are key proposals and how they could impact some sections of taxpayers.

Simpler Tax Regime for Individual and HUF Taxpayers

With an aim to spur private consumption and rejig the existing slab rates, the FM delivered a new simplified optional tax regime for individual and HUF taxpayers. The simplified tax regime comes with a rider that, a taxpayer can opt for the regime only when he foregoes the tax benefit currently available in relation to housing loan interest paid on the self-occupied property, house rent allowance, contribution to provident fund, life insurance premium, medical insurance premium and others deductions. Considering that we lack a robust social security system, the taxpayers will have to make an informed decision before opting between the existing regime and the proposed scheme. 

In the case of individuals / HUF with business income, this option once exercised becomes irreversible. However, in case there is no business income, the taxpayer can select the regime on a year on year basis while filing the tax return. Such option unless determined at the beginning of the year may pose a practical challenge to the employer while deducting tax (TDS) from salary or the taxpayer while paying advance tax. 

Changes to Tax Residency Rules

Tax authorities globally have expressed concerns on stateless persons and residency planning resulting in double non-taxation. The budget has proposed changes to tax residency criteria to curb such instances. According to the budget proposal, an Indian citizen would be deemed to be a resident in India, if such an individual is not liable to tax in any other country or territory by reason of his domicile or residence or any other criteria of similar nature. Once a resident, global income of such individuals is taxable in India. A bare reading of this proposition meant that Indians working in the Gulf countries for years and paying no taxes in the absence of any personal tax system therein would be taxable in India. Realising the hardship it may cause to genuine citizens seeking employment in such regions, the government immediately clarified that the proposed deeming provision is an anti-abuse provision and bona fide Indians working in other countries, even if not paying taxes, would not fall within the ambit of deeming fiction.

Furthermore, Indian citizens or Persons of Indian origin who visit India, are able to carry out substantial economic activity from India without paying any taxes here, merely by limiting their stay in India below 182 days. To arrest this abuse, the budget proposes to trigger tax residency in India at a lower trigger of 120 days of stay in India as against the existing threshold of 182 days. Accordingly, if such individuals visit India and are physically present here for 120 days or more during a particular tax year and also fulfil the condition of being in India for 365 or more days in the past 4 years, they would be regarded as residents and their global income would be subject to tax in India.

The FM also proposed that for an individual to qualify as a ‘Not Ordinarily Resident’ in India, he/she would have to be Non-resident in India in 7 out of 10 preceding financial years (as against 9 out of 10 previously). The second condition of physical stay in India for less than 730 days during the preceding 7 financial years is proposed to be done away with. In other words, someone who has not even come to India for a single day in the last 2 years but has been a resident in the preceding 8 years, will be considered as ‘Resident and ordinarily resident’ and their global income will be liable to tax in India.

Abolishing Dividend Distribution Tax 

In response to a long-standing demand of investors, the FM proposed to abolish the Dividend Distribution Tax (DDT). As per the current Income tax law, once DDT has been paid on dividends declared, dividends were not taxed in the hands of shareholders. However, DDT is a tax on the distribution, for which neither the payer company nor its shareholders could claim the credit. With the proposed change, the company would no longer be liable to pay DDT on the dividend declared, distributed or paid on or after 01 April 2020, but the same would now be taxed in the hands of the shareholders. For non-resident shareholders, the tax could be restricted to rates prescribed by the tax treaty India has with the counterpart country, and for resident shareholders, the taxability may depend on the applicable tax bracket. This is likely to adversely impact cases of taxpayers in the higher tax brackets. 

Earlier, as dividend income was not taxed, no deduction was allowed for any expenses (say interest) incurred to earn the dividend income. While dividend income is now fully taxable, the deduction for expenditure is restricted to 20% of dividend income. In cases of highly leveraged investments, this is likely to result in higher tax outgo.

Start-up Boosts

Considering that India is one of the largest start-up eco-system in the world, the budget has proposed two major proposals for this sector. According to the current provisions, an eligible start-up could claim a 100% tax holiday for 3 consecutive years in a window of 7 years from its incorporation. As early-stage start-ups may not have adequate profits to avail the tax holiday, they would now have an extended window of 10 years for utilising the 3 year tax holiday. The tax holiday is available only to an eligible start-up. In order to provide tax relief to larger start-ups, the budget proposes to amend the definition of ‘eligible start-ups’ by increasing the turnover limit from INR 25 crores to Rs 100 crore. 

Currently, an individual is taxed on income in respect of ESOPs at two occasions, as a prerequisite at the time of allotment/transfer of shares i.e. at the exercise of options; and as a capital gain at the time of sale of shares. The employees receive shares/stock (not cash) upon exercise, tax is computed on notional value and withheld from the cash salary. This results in cash flow challenges for employees. In order to ease the burden of tax payment for employees of eligible start-ups, the FM introduced a proposal to defer the taxability of ESOP in case of eligible start-ups.

It is to be noted that to avail the tax benefits, a start-up is required to register on the DPIIT portal and obtain approval from the Inter-Ministerial Board of Certification. As per data available on start-up India portal, more than 28,000 start-ups have been recognised by DPIIT, out of which only 250 start-ups have been granted an exemption under Section 80-IAC and thus eligible to avail the said tax benefits. Along with tax boosts, it is expected that the government will match it with administrative efficiency, which will help start-ups enjoy the tax breaks announced.

Tax Dispute Settlement Scheme

Modelled along the lines of the Sabka Vishwas Scheme (to settle Indirect tax disputes), the FM proposed the ‘Vivad se Vishwas’ tax dispute settlement scheme for Income tax. Under this scheme, the taxpayer will be required to discharge the disputed tax liability (tax arrears) and will receive a complete waiver of the interest and penalty, provided the disputed tax is paid before 31 March 2020. The benefit under this scheme can be availed post-March 2020 until the end of June 2020 subject to payment of an additional amount of up to 10% of tax arrears. The scheme is a good option to conclude long-pending tax litigation, where interest/penalties on tax dues could sometimes be more than the tax demand itself. 

While the Sabka Vishwas scheme could collect about INR 30,000 crore, there are approx. INR 7-8 lakh crores stuck indirect tax litigation and this scheme could be a good way to unlock value for the government. However, a majority of the litigation arising is on account of aggressive positions taken by lower-level tax authorities where the taxpayer expects relief from the appellate authorities; and hence may not opt for this scheme. In case the government provides some abatement on the tax arrears, similar to the Sabka Vishwas Scheme, it would significantly bring down the pending litigation. Furthermore, in order to deliver the promised non-adversarial tax regime, the government must clarify that any amounts of interest and penalties already paid but in excess to that determined under this scheme would be refunded, if the taxpayer opts to settle the dispute under this scheme.

Continuing Reforms

Though the Union Budget has sought to address many of the concerns of the taxpayers, it has not addressed some of the key expectations such as restoration of exemption of long-term capital gain on equities, allowability of CSR expenditure, tax rate disparity between corporates and LLP, abolishment of ICDS, among the long list of taxpayer expectations. Considering the existing bottlenecks, the government will have to continue with the reform measures throughout the year to revive the consistently slowing economy, especially manufacturing sector & job creation, and not just bet on foreign investment to reach the USD 05 trillion economy target.