Private Client Practice: Some Recent Legal Developments

2019 has thus far been an eventful year for private clients. We have had a General Election accompanied by two Budgets, and the introduction of some important legal provisions through money bills and otherwise. We have briefly discussed below some of the key proposals from the latest Finance (No. 2) Act, 2019, which received Presidential assent on August 1, 2019 (‘Finance Act’), along with a snapshot of certain other important developments for private clients this year.

1.       FINANCE ACT

1.1.     Surcharge on HNIs: A surcharge is a tax that is levied in addition to the specified base rates of tax. Individuals are currently subject to a 10% surcharge if their total income is between INR 50,00,000 (approx. USD 70,000) to INR 1,00,00,000 (approx. USD 140,000) (with marginal relief), or a 15% surcharge if their total income is above INR 1,00,00,000 (with marginal relief). The Finance Act has increased the surcharge from 15% to 25% where the individual’s total income is between INR 2,00,00,000 (approx. USD 280,000) and INR 5,00,00,000 (approx. USD 700,000) (with marginal relief) and to 37% where the total income exceeds INR 5,00,00,000 (with marginal relief). This has resulted in an effective maximum marginal rate of:

(a)      35.88% if their total income is between INR 1,00,00,000 to INR 2,00,00,000;

(b)      39.00% if their total income is between INR 2,00,00,000 to INR 5,00,00,000; and

(c)      42.74% if their total income is above INR 5,00,00,000.

The surcharge is also applicable to taxpayers other than individuals, such as Trusts, Hindu Undivided Families, Associations of Persons etc., although certain relief measures have been introduced for foreign investors on capital gains. Since the rate may increase substantially, Non-resident taxpayers would need to evaluate whether these amounts would be creditable in their home jurisdictions.

1.2.    Foreign investment: To promote greater investment by non-resident Indians (‘NRIs’) and foreign portfolio investors (‘FPIs’), the Government has proposed to: (i) merge the NRI portfolio investment route with the extant FPI route; (ii) simplify know-your-customer (‘KYC’) norms for FPIs; and (iii) enhance the FPI limit from 24% to the permitted sectoral limit at the option of the concerned investee company.

1.3.     Buyback of Listed shares: The Finance Act has extended the company level buy-back tax to companies listed on recognised stock exchanges. Previously, under Section 115QA of the Income-tax Act, 1961 (‘ITA’), buyback distributions by unlisted companies at the company level were taxed, by levying an additional income tax on the distributing entity. The tax was levied at the rate of 20% (exclusive of surcharge and cess) on the distributed amount, as reduced by the issuance price. Now, any buy-back of listed shares on or after July 5, 2019 (except buy-back of listed shares in respect of which public announcement has been made before July 5, 2019), will also be subject to a buy-back tax of 20% (exclusive of surcharge and cess). Consequently, the amount received by the shareholders will be exempt from tax under Section 10(34A) of the ITA. Since the tax is imposed on the difference between the buy-back price and the issue price, it may result in a double tax on capital gains accruing from prior transfers. Further, any non-resident shareholders receiving buyback distributions may not be able to claim foreign tax credit in their home jurisdictions, unless they are eligible to underlying tax credit. This is because shareholders are exempt from tax obligations once the company pays the additional distribution tax.

1.4.     Disclosure of foreign income and assets: The (Indian) Finance Ministry has introduced the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 (‘Black Money Act’), requiring broad disclosures by ‘Indian residents’ in relation to foreign income and assets. The Finance Act has also extended the definition to include non-residents or not-ordinarily resident individuals, who will now be subject to the requirements of the Black Money Act if they were resident in India at the time of acquisition of the relevant foreign income and assets. A clarificatory amendment has also been introduced to provide for reassessment of such undisclosed overseas income or assets.

1.5.     Interchangeability of PAN and Aadhaar: The Finance Act has introduced amendments to enable: (i) the allotment of Aadhaar to NRIs on arrival without a waiting period; and (ii) the interchangeability of Permanent Account Number (‘PAN’) with the Aadhaar number for persons not having a PAN and for persons who have linked their PAN and Aadhaar under Section 139A of the ITA.

1.6.     Charitable institutions: Procedural amendments have increased the powers of tax authorities over religious and charitable institutions which are registered as tax exempt entities under Section 12AA of the ITA.

1.7.     Prevention of Money-Laundering Act, 2002 (‘PMLA’): Reporting entities under the PMLA are now required to take additional due diligence measures to: (i) authenticate the client’s identity; (ii) examine the ownership and financial position of the client including determining the sources of funds; (iii) identify the purpose behind transacting parties and the nature of the relationship between the parties; and (iv) increase future monitoring of the client in case of any suspicion. These measures are to be undertaken prior to the commencement of a transaction. Further, such information is to be maintained by the reporting entity for a period of five years from the date of transaction between the reporting entity and the client. If a reporting entity, its designated director, or any of its employees fail to comply with such obligations, then the maximum monetary penalty imposable on such persons is INR 1,00,000 (approx. USD 1400) for each failure and it will not be less than INR 10,000 (approx. USD 140).[1] Alternatively, a warning letter or a direction to comply with specific instructions may also be issued by the director appointed under the PMLA.

2.       COMPANIES (SIGNIFICANT BENEFICIAL OWNERS) AMENDMENT RULES, 2019 – CRITICAL CONSIDERATIONS FOR A TRUST

2.1.     Background

Earlier this year, on February 8, 2019 and July 1, 2019, the Ministry of Corporate Affairs (‘MCA’) issued the Companies (Significant Beneficial Owners) Amendment Rules, 2019 (‘Amendment Rules’), and Companies (Significant Beneficial Owners) Second Amendment Rules, 2019 (‘Second Amendment Rules’), amending the provisions of the Companies (Significant Beneficial Owners) Rules, 2018 (hereinafter collectively referred to as the ‘SBO Rules’). Every ‘individual’ who is considered to be a ‘significant beneficial owner’ (‘SBO’) for a reporting company (i.e. a company incorporated in India as per the Companies Act, 2013), is required to file a declaration with the reporting company in Form BEN-1. The Second Amendment Rules amended and notified Form BEN-2. Our analysis of the SBO Rules in our previous alert is available here. There are practical difficulties and issues faced by trusts in identifying which person is required to make disclosures under the SBO Rules, as further explained below.

2.2.     Determination of a SBO

There are two tests to assess whether an individual is an SBO in a reporting company i.e. an objective test and a subjective test:

(a)      The objective test considers whether the individual indirectly, or together with any direct holdings, holds 10% or more either of shares, voting rights in the shares or right to receive or participate in total distributable dividend or any other distribution.[2]

(b)      The subjective test considers whether an individual has the right to exercise or is exercising ‘significant influence or control’[3] other than through direct holdings alone.[4] ‘Significant influence’ means the right to ‘participate’ in financial and operating policy decisions of the reporting company, without necessarily having any control over them.[5] This is a broad definition, and mere ‘participation’ in financial and operating policy decisions will imply that the individual is considered an SBO. The extent of ‘participation’ will have to be evaluated on a case to case basis.

2.3.     Holding by a trust

The SBO Rules lay down various parameters to determine whether an individual holds a right or entitlement indirectly in the reporting company. This is based on the type of member (for example, body corporate, partnership entity, trust, etc.) and the relationship such individual shares with the member of the reporting company.

In the context of trusts, there are some aspects of the SBO Rules which are not entirely clear. For instance, the SBO Rules state that the SBO for discretionary trusts would be the individual who is a trustee of the trust. However, they do not contemplate a situation where the member of the reporting company has a body corporate as the trustee.[6] Similarly, while they state that the SBO of a specific trust would be any individual beneficiary holding more than a 10% interest, they do not contemplate a situation where non-individuals such as partnerships or bodies corporate could be beneficiaries.[7] Although private trusts set up by families are frequently discretionary and not specific, there are instances where specific trusts may be used to allocate crystallised shares. Similarly, there may be situations where multiple individuals are identified as SBOs. For example, where the member of the reporting company is a trust which is both revocable and discretionary, the settlor and trustee/s would be considered SBOs. However, where the member of the reporting company is a trust which is both revocable and specific, the settlor and beneficiary would be considered SBOs. It is common practice for trusts to be set up in this manner, and the question remains as to whether both or either of such individuals should make disclosures under Form No. BEN- 1.

3.       AMENDMENTS TO THE INDIAN STAMP ACT, 1899: TRANSFERS OF SECURITIES WITHOUT CONSIDERATION

3.1.  Important amendments were also made earlier this year to rationalise the stamp duty applicable on transfer of securities. We briefly analysed these changes in our previous alert available here. What is most relevant for private clients, is that as per the revised provisions as they currently stand, no stamp duty has been imposed on the transfer of securities for no consideration (for example, through a gift).

Previously, transfers of demat securities were not subject to stamp tax, although transfers of physical securities were subject to a stamp duty of 0.25% on the share transfer form. As per the revised provisions, no stamp duty seems to be imposed on the transfer of demat or physical securities, if such transfer is without consideration. It is significant to note that if the transfer is by way of a gift deed, family settlement agreement or other form of conveyance, such instrument would continue to be taxable. Further the amendments to the Indian Stamp Act, 1899 contained in Chapter IV of the Finance Act are yet to come into force.[8]

[1] Section 13(2) of the PMLA.
[2] Section 2(h) of the SBO Rules.
[3] Section 2(b) of the SBO Rules, “control” includes the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
[4] Section 2(h)(iv) of the SBO Rules.
[5] Section 2(i) of the SBO Rules.
[6] See Explanation III(iv)(a) to section 2(h) of the SBO Rules.
[7] See Explanation III(iv)(b) to section 2(h) of the SBO Rules.
[8] Section 11 of the Finance Act.

Date: September 25, 2019