Introduction

1. The start of the new Financial Year 2020-21 has not been promising for a lot of countries, including India. The pandemic, Covid-19 has brought to test the firefighting abilities of Nations with the world’s economic well-being now at stake. Testing times pose an opportunity for many who are quick to act. With China’s swift fall from grace in the handling of this pandemic, many developing Asian countries now have an opportunity to present themselves as manufacturing alternatives to China. India’s economic landscape and the recent tax reforms make it an attractive destination for new manufacturing activities and foreign investments, especially for countries who were dependent on China for raw materials, components, several merchandise, etc.

   One much touted tax reform has been the introduction of the Section 115 BAB of the Act in the Taxation Laws (Amendment) Ordinance, 2019 passed on the 20th of September 2019 offering a lower tax rate of 15% (plus applicable surcharge and cess), for new manufacturing domestic companies. The reform was specifically introduced to incentivise fresh investments and commercial ventures in the realm of manufacturing and was harmonious to the Government of India’s make in India campaign.

2. The coronavirus pandemic has caused a meltdown in the global supply chains making domestic companies think of ways to insulate themselves from the vagaries of the global supply chains and to delink their dependence on import. Given this need of minimising risk, Section 115 BAB of the Act would definitely act as an incentive for Indian companies to allocate capital and invest in new manufacturing opportunities to beef up their respective supply chains and reduce outside dependence.

   The base tax rate of 15% for new manufacturing investments makes India a country with one of the lowest corporate tax rates in the region comparable only to Singapore with 17% tax rate. Even Vietnam, Thailand, Taiwan and Cambodia have 20% as their base tax rates etc. When coupled with the discontinuance of the DDT required to be paid by companies for distribution of profits in the form of dividends, Indian comes across as an attractive investment opportunity for Foreign Direct Investments.

3. Section 115 BAB of the Act: Tax on income of new manufacturing domestic companies:

• A domestic company would be entitled to the benefit of this lower corporate tax rate, if it satisfies the conditions stated in subsection (2) of section 115BAB of the Act being:

  1. The company has been registered or set up on or after 1st October 2019 and has commenced manufacturing on or before 31st March 2023.

  2. It should not have been formed by the splitting up and reconstruction of a business already in existence, except in case of a business re-established under section 33B of the Act.

  3. It should not use any plant or machinery previously used for any purpose. However, the company can put to use plant and machinery used outside India, if it is imported and used in India for the first time. Secondly, the company can also use old plant and machinery, provided that the total value of such plant and machinery does not exceed 20% of the total value of the plant and machinery used by the company.

  4. It should not use a building previously used as a hotel or a convention centre, in respect of which deduction under section 80-ID of the Act has been claimed and allowed.

  5. The company should not be engaged in any business other than manufacture or production of an article or thing. Research and distribution of such article and thing would be considered a valid activity. However, manufacture and production of an article and thing would not include: (i) Development of computer software in any form or media; (ii)Mining; (iii) Conversion of marble blocks or similar items into slabs; (iv) Bottling of gas into cylinder; (v) Printing of books or production of a cinematograph film; (vii) Any other business as may be notified by the Central Government.

  6. The total income of the company should be computed without claiming tax deductions such as:

     1. Deduction under section 10AA of the Act for units in Special Economic Zone.

     2. Deduction for additional depreciation under section 32 of the Act and the investment allowance deduction under section 32AD of the Act towards new plant and machinery investments made in notified backward areas of certain states.

     3. Deduction under section 33AB of the Act for tea, coffee and rubber growing or manufacturing entities.

     4. Deduction towards deposits made towards site restoration fund under section 33ABA of the Act by companies engaged in extraction
        or production of petroleum
        or natural gas or both in India.

     5. Deduction for scientific research expenditure made under section 35 of the Act.

     6. Deduction for capital expenditure incurred by any specified business falling under section 35AD of the Act.

     7. Deduction for the expenditure incurred on an agriculture extension project under section 35CCC of the Act or a skill development project under section 35CCD of the Act.

     8. Deductions under Chapter VI-A in respect to certain incomes, except for the deduction under section 80JJAA of the Act.

  7. The total income of the company should be computed without the set-off of any loss or unabsorbed depreciation deemed so under section 72A of the Act, carried forward from earlier years, if such loss or depreciation pertains to the deductions mentioned above.

  8. Depreciation under section 32 of the Act, would be allowed, except clause (iia) of subsection (1) of the said section, being that of additional depreciation.

• Transfer pricing provisions would be applicable in certain cases, where due to a close connection between the company and any other person, or for any other reason, the business between them is so arranged such that the company earns more than ordinary profits, the assessing officer may ignore the excess profits. The Assessing Officer will take only the amount of profits reasonably deemed to be derived from the business.

  Also, in a case where the business transaction involves a specified domestic transaction referred to in section 92BA of the Act, the profits of the transaction will be determined having regard to the arm’s length price.

• Furthermore, companies opting for this section will not be required to pay minimum alternate tax (MAT) under section 115 JB of the Act.

Hence, if any new manufacturing company wants to exercise the option of being taxed under section 115BAB of the Act, it can do the same on or before the due date of filing income tax returns and avail the favourable tax rate of 15% (plus applicable surcharge and cess). Once, the company opts for this section in a particular financial year, it cannot be subsequently withdrawn.

4. Dividend Distribution Tax (DDT): The Finance Act , 2020, abolished the DDT paid by companies declaring dividends for distribution of their profits. Earlier, DDT was paid by domestic companies at an effective rate of 20.56%, the dividend being exempt in the hands of both the domestic and foreign shareholders. However, for resident individuals, HUFs and firms receiving dividend in excess of ₹10 Lakhs, additional tax on dividend at the rate of 10% was leviable further added by surcharge and cess as applicable. These taxes were over and above the corporate income tax payable by the dividend distributing company on its taxable income.

5. For foreign shareholders looking at repatriating profits, DDT was always a pain point resulting into double taxation. Given that DDT was paid at the domestic company level and not at the investor level, the foreign investors receiving such dividend were unable to apply the beneficial tax rates available in India’s Double Taxation Avoidance Agreements (DTAA) and hence, were often unable to claim tax credit in their home jurisdiction. The net result of the above was that the income of the Indian company was taxed twice before reaching the foreign investors and further taxed in the hands of the foreign investors as per the tax laws of their home jurisdiction without availing any tax credit as per their tax residence.

   The Finance Act, 2020, proposed that dividends paid to foreign shareholders would be subjected to a withholding tax at 20% under section 115A of the Act. However, the foreign shareholder could now be eligible to avail a lower withholding tax rate, if so prescribed under the relevant tax treaty. Treaties with certain jurisdictions prescribe such lower rates e.g. United States (15%), Singapore (10%), Mauritius (5%) etc. Hence, the abolition of DDT would result in enhancing the return on equity capital for foreign investors, as the taxes withheld in India on dividends received by them now can be claimed as a foreign tax credit, in their respective home jurisdictions.

6. To get an understanding of the quantum of potential tax savings using Section 115BAB of the Act, followed by the discontinuance of DDT, the comparison can work out as follows:

   Case 1: A Singapore company starting new manufacturing activities in India post 01.10.2019, satisfying the conditions under section 115BAB of the Act, and repatriating profits in the form of dividends post 01.04.2020.

   Case 2: The same Singapore company having existing investments in an Indian company, having repatriated profits as dividends before 01.04.2020. (Assumption: Turnover of Indian company up to 400 Crores; hence tax rate at 25%)

Hence, based on the above illustration, we get to see that investing in new manufacturing activities in India post these favourable tax reforms would be highly rewarding to a foreign investor with a long term perspective, given that these tax reforms are here to stay.

CONCLUSION

7. These provisions envisaged by these tax reforms bring India’s tax effectiveness close to most emerging economies in this part of the world for investors. Since the launch of the government’s ‘Make in India’ initiative in September 2014, India has significantly progressed in the World Bank’s ease of doing business ranking, being 63rd among 190 nations and clocking an improvement of 14 places from being 77th in the last year as per 2019 ranking report. During the current challenging times, India has portrayed its resilience to the world by being able to contain the Covid-19 virus in a more effective way than most countries. These factors collectively aim at shoring up investor confidence and moving ahead, will help in attracting new capital, especially in the manufacturing space and help creating various other opportunities for the country as well as investors.