By Nandita Tripathi, Nirmal Nagda and Mugdha Godbole,
Development of infrastructure has been a clear focus area for this Government since the past few years and multiple initiatives have been undertaken to provide impetus and funding avenues to this capital-intensive sector. In the backdrop of the current pandemic, alongside progressive policy initiatives, the sector is looking forward to much-needed tax reforms so as to enhance the pace of infrastructure creation.
While it would be unfair to say that the Government of India has not provided tax reliefs to the infrastructure stakeholders in the past, yet, the industry is facing some challenges inter alia from a direct tax perspective and is hopeful that they would be addressed in the upcoming Union Budget 2021.
In the previous Budget, stakeholders welcomed the move of granting tax exemption to Sovereign Wealth Funds /Pension Funds (SWF/PF) on income streams from infrastructure investments subject to conditions, but this move is not devoid of challenges. To provide more comfort to the investors, it can be clearly spelt out that the exemption is available for investments made through wholly-owned special purpose vehicles of the investors. Further, there are instances of tax lock-up in the hands of SWF / PF owing to withholding tax provisions that do not provide a carve out for their exempt income. For instance, where SWF / PF would make debt investment in eligible companies (through FPI route or vide loan agreement or rupee-denominated bonds), withholding tax will apply on interest paid at applicable rates.
While extending most tax reliefs and tax pass-through status to Infrastructure Investment Trusts ie InvITs (including private unlisted InvITs) has been a welcome move, there are few tax inefficiencies which need to be plugged. Such as, while interest on securities and dividend income being tax-exempt in the hands of InvIT, withholding tax on such payments by SPV to InvIT leads to cash lock-up and needs to be done away with. Similarly, withholding tax on the dividend by InvIT to the non-resident at flat rate of 10% (without considering beneficial tax treaty provisions) leads to undue hardship to investors which can be avoided. Also, the migration to InvIT is driven by commercial factors and hence, in such genuine cases the tax losses at the project SPV level should continue even where there is a change in shareholding of more than 51% pursuant to migration to InvIT.
The infrastructure sector also accounts for the majority of stressed assets in India and turning around these stressed assets can be challenging. From a tax perspective, previous budgets have provided certain reliefs for companies under the Insolvency and Bankruptcy Code. However, the unfinished agenda includes, relaxing the applicability of deemed income provisions to the acquirer, considering that the acquisition price could be lower than the book value / listed price of the company. Further, hair cut to the lenders (and resultant loan waiver), could lead to tax implications under normal as well as Minimum Alternate Tax (assuming MAT is applicable) for the company, making it costlier for the acquirer to turnaround the asset and hence, calls for relaxation.
Earn-out arrangements (where a buyer pays consideration to seller subject to fulfilment of conditions) have been prevalent in the infrastructure space and the construct has gained more importance during recent times. While the commercial merits of earn-outs are widely acknowledged, the lack of clarity on tax has been a dampener. Contrasting judgements have been passed on this issue and upfront tax, without the certainty of actual realisation, which can significantly increase the transaction costs. Clarity on the taxability of earn-outs will provide comfort to the stakeholders.
With respect to debt investments, Government of India has provided lower withholding tax rate of 5% for interest payments on External Commercial Borrowings, Rupee Denominated Bonds and investments by Foreign Portfolio Investors (FPIs) with a sunset clause subject to certain conditions. To provide comfort to the investors to invest for a longer period, the Government can consider extending the sunset date for the beneficial withholding rate of 5% to perpetuity.
There has been unrest pursuant to a recent Supreme Court ruling due to which FPIs may be subject to higher withholding tax rate as per the domestic tax law (without considering the beneficial tax treaty provisions). In order to avoid lock-up for FPIs and undue hardship, withholding taxes on payments to FPIs should be subject to withholding taxes at ‘rates in force’.
Considering that foreign investments play a significant role in the development of country’s infrastructure, current restrictions imposed vis deducibility of interest paid to associated enterprises (under section 94B) should be done away with, for companies operating in the infrastructure sector. Further, a lower corporate tax rate of 15% for new ventures is currently available for the power sector only (within the infrastructure sector). With a view to further incentivize infrastructure growth, the same should be expanded to include all sub-sectors of infrastructure sector as per the harmonized list.
While we expect the Government to increase expenditure on infrastructure, steps taken to reduce tax challenges, bringing more clarity and extending specific tax reliefs (pertinent for the sector), will go a long way in developing the infrastructure sector at the desired pace and re-ignite the economic recovery of the country.
(Nandita Tripathi is Partner, M&A and PE Tax at KPMG India and Nirmal Nagda and Mugdha Godbole are Chartered Accountants)