With the changing landscape of Indian businesses, we are witnessing a significant and rapid geographical shift in doing business. Recent times have seen the Indian multinationals regularly flexing their muscle abroad. Not only has the last few years seen established Indian business houses making significant outbound investments into capital intensive sectors such as Energy, Telecom and Technology but recent times have also seen young home grown Indian companies itching to create a global presence within just few years of their operations. These illustrations are demonstrative of the speed at which the Indian economy is flipping over from being an inbound to an outbound centric economy.
The question then arises is whether we are on course to establish ourselves as an outbound centric economy (like many developed economies like USA, Japan and China). If that holds true the next obvious question would be whether our tax regime is geared for such a potential flip? Will Budget 2015 address this question?
Lessons from the past
Just to recap, the opening of the Indian economy had seen a flood of inbound investments into India. While the opening up of economy provided a great impetus to the GDP growth rate of the country, lack of potential clarity on tax laws gave rise to the multi-billion dollar tax litigations. This battle has left the victors and the losers both badly bruised. But the dust seems to have settled, with the current Government making every effort to restore the confidence of the foreign investor.
Need for a taxation framework governing outbound investment
Taking a cue from the past, the Government must set the record straight before the flip happens rather than taxing outbound investments retrospectively. The consequences for failing to do so, may be far direr. Unlike inbound investment into India, the subjects of outbound investment are inevitably Indian resident. This factor may prove very costly to the Government, as losing the confidence of your own resident may break the backbone of the Indian economy itself.
India can take a cue from developed economies, such as the United States, in which the predominant form of investment is outbound. The United States has detailed regulations governing outbound investment such as (1) Check-the-box regulations governing foreign entity classification, (2) Subpart F regulations governing passive income earned by Controlled Foreign Corporations (CFCs) abroad (3) Various rules and regulations governing corporate reorganization of offshore subsidiaries. One does appreciate that it may not be in India's interest to copy and paste its way through. Having said that, it may be useful for the Government to take a look at these rules and regulations and customize them to fill the vacuum in the current tax regime.
Current Indian tax regime on outbound investment
A frail attempt at regulating taxation of outbound investment was made in the Direct Taxes Code (DTC). The DTC saw (1) regulations pertaining to passive income earned by CFCs located in low tax jurisdictions, (2) sparse discussion on taxation of cross border mergers and (3) the all-encompassing General Anti-Avoidance Rules (GAAR). As it stands currently, the DTC is yet to see the light of day. With this, the outbound taxation space is left with a large vacuum. Add to this, the provisions of GAAR are likely to be introduced from 1 April, 2015. One hopes that this vacuum will not be filled with the exercise of discretionary power of the Revenue Authorities, thereby killing the appetite of Indian multi-nationals who have finally started creating a global presence.
Expectations from the Budget
With the Union Budget just around the corner, Indian multinationals are hoping for a robust and comprehensive tax law pertaining to outbound investment which could include the following:
• Rules governing foreign entity classification. With the expansion of Indian business into various countries, the Government should lay down detailed guidelines for foreign entity classification. For example, would a US Limited Liability Company (which has the characteristics of an Indian corporate but is a pass through entity from a tax perspective) be considered as a partnership or a company for Indian tax law purposes? So far, this characterization has been made on an ad-hoc basis by Indian Courts.
• Rules defining the taxation of passive income earned abroad. Most developed economies (like United States, Japan, etc.) have laid down rules governing the taxation of passive income through their CFC regime. In the absence of detailed guidance in India, there is an apprehension that GAAR provisions would be invoked arbitrarily and in-discriminately in all cases of passively earned income.
• Rules governing foreign business reorganization: There is little guidance on foreign reorganisation of businesses. In the fast changing world of multinational businesses, companies need to be flexible and supple. Law is no different. Robust rules must be laid down to give Indian multinationals the flexibility to reorganize their global operations quickly, without compromising on their tax dues.
Conclusion
A mature and futuristic tax regime for outbound investments requires the Government to be the proverbial "honey bee" and change its attitude from being a mere tax collector to a tax regulator driven with the objective of providing tax certainty. If we truly want to encourage home-grown promoters to create a global presence, the best time to introduce a healthy tax framework governing outbound investments is now. Will the Government make it happen? Like all other answers, this answer too lies in the Finance Minister's briefcase!
Raju Kumar
Author is a Partner with Tax & Regulatory Practice at EY India
(Harshal Shah, senior tax professional, EY contributed to the article)
(Views expressed here are personal)
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