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The Monsoon Blues

By Laurence E. Lipsher - Email Editor

Dear Valued Reader,

It's monsoon season, and the weather is what we've come to expect in Asia at this time of year - miserable I am shuffling along at a slower pace, similar to the speed of actual tax amendment in India. China, however, is rolling right along with changes to its tax policies.

The Chinese government announced July 7 that it will impose a nationwide tax on oil and gas drilling and other resource industries to fund development in the west.

Beijing is actually carrying out a test of this tax in the western region of Xinjiang. That province will be the prime beneficiary of national tax renminbi coming into the minority areas that just happen also to be rich in coal and gas deposits. Xinjiang imposed a 5 percent tax in June. Once this tax is imposed nationwide, it is likely to be determined on a product-by-product basis. Beijing will invest CNY 686 billion in 23 projects in the western region alone during 2010.

The Xinjiang province produced 13 percent of China's crude petroleum in 2009. The tax revenues alone from this province could amount to US $730 billion per year, the China Daily reports.

There are already tax concessions for enterprises going west, where corporations are subject to a 15 percent corporate tax, compared with the 25 percent standard corporate tax rate for most of the rest of the country. Resource producers previously paid a resource tax of CNY 14 to CNY 30 per ton of crude oil output and CNY 7 to CNY 15 per 1,000 cubic meters of gas, depending on the location and quality. When this takes effect throughout the whole country, it will be at a higher price base overall, the South China Morning Post reports, as gas prices alone have increased in China by 25 percent since June 1.

What will this do to the corporate bottom line? Chinese analysts are predicting that oil producers in Xinjiang will lose about 1 percent of their net profit (remember, they were previously taxed as resource taxes), while the impact on national producers never taxed before in this area will result in a 10 to 11 percent bottom-line drop in profit next year.

Offshore holding companies will no longer have tax benefits because of beneficial ownership and effective management rules that were announced toward the end of 2009 that are now being implemented.

If the State Administration of Taxation (SAT) deems the offshore company's day-to-day management as taking place in China and not offshore, that offshore company will be subject to corporate income tax in the P.R.C.

If that offshore company effectively has no substantive business activities in its home jurisdiction, it will not qualify for reduced withholding tax rates under the double tax avoidance agreements (DTAAs) between that jurisdiction and China.

If the outside investor sells the foreign ownership of the Chinese business and that foreign ownership did not exceed 25 percent of ownership in the year, the DTAA will be valid. But if transfer of ownership is more than 25 percent, then forget about it, you'll be hit by tax from China — no ifs, ands, or buts.

This is a situation that perhaps calls for analysis of what it takes to make it as a true offshore owner, where enough business transpires to make it valid, and where decisions are made. True, this may be a herculean task in many cases, but in many others, it will not be difficult to overcome these obstacles. Studying the Chinese laws on the subject matter and the DTAAs for your jurisdiction just might pay some healthy rewards.

DTAAs

Speaking of DTAAs, as fast as Hong Kong is moving along its path from OECD blacklist to white, shipping companies are lashing out at the Hong Kong government for not going far enough, fast enough. Shipping firms are asking for double tax avoidance treaties with Australia, Brazil, India, and South Africa, according to the South China Morning Post. Spot voyage charter markets face tax on cargo freight value at each port of call without DTAAs in place. With iron ore prices skyrocketing (enough to bring down a government in Australia) and no double tax treaty with ironore- producing countries, Hong Kong shippers have a current tax liability of more than HK $2.6 million as Australian freight tax alone. Local companies in Australia are taxed on operating results. DTAA-country shippers are exempt either wholly or substantially, while Hong Kong is left in the lurch. I expect that now, with a new spirit of DTAA reckless abandon, Hong Kong will likely begin negotiations with various jurisdictions to rectify this situation soon.

India

In my last article I discussed the significant amendments to the Direct Tax Code (DTC). (For prior coverage, see Tax Notes Int'l, July 26, 2010, p. 265, Doc 2010- 15974, or 2010 WTD 142-15.) Ostensibly, this is all going to make doing business in India easier for non-Indians, but don't be so sure.

The Nation, in a May 14 op-ed taken from the Guardian News Service, said that it is India's fat cats - headed by Reliance Industries Chair Mukesh Ambani, the richest man in the country — who are fighting any semblance of ease for foreign enterprises wanting to enter India to do business. There is an abundance of rules - especially in taxation - that the business elite have established, making it extremely difficult, if not actually impossible, for the larger multinationals to start up.

Earlier this year, the World Bank's "Ease of Doing Business" report ranked India way down at number 133 out of 183 nations for ease of setting up shop. Thailand ranked number 12, while Singapore, as you might expect, came in first.

The five-judge constitutional bench has ruled that the National Company Law Tribunal, the arbitrator in determining acceptability of multinationals, can only be created on amending the constitution, the Business Standard reported. The National Tax Tribunal, initially envisaged as a fast-track alternative in dispute resolution regarding the National Company Law, was supposed to be simultaneously set up, along with the National Company Law Tribunal, by the Lok Sabha, India's lower house of Parliament.

Thus, the 42nd Amendment, which introduced article 323-B to the constitution, is now being questioned. This amendment deals with cases involving levy of any tax, foreign exchange, customs duties, industrial, and labor disputes. The Business Standard predicted that delinking the National Tax Tribunal will likely mean several years before it is finally set up.

Be warned: If you want to set up shop in India - and remember, the size of the middle class with expendable rupees is more than 200 million - having lots of patience will definitely help overcome the obstacles that foreign companies will encounter.

An example of those obstacles appeared in the June 6 Business Standard. Vodafone PLC bought out Hutchison from Hong Kong's famous billionaire Li Ka-Shing, chair of Hutchison Whampoa Ltd. and Cheung Kong Holdings. India wanted a DTAA with Hong Kong expressly to go after taxing Li. India is getting that DTAA, but with "protection" for Hong Kong's richest individual, so guess what is happening? India is now going after Vodafone, assessing its tax liability at INR 12,000 crore on its 2007 acquisition of Hutchison's telephone operations in India. Vodafone is now the second largest telecommunications company in India, with more than 100 million customers. While things usually take time - a whole lot of time - to function in India, the notice to Vodafone was made during the first week of June, and yet Vodafone was given until June 14 to answer. Tax life is always interesting in India.

In Delhi, entry to the North Block (where the Finance Ministry is located) was restricted before the Direct Tax Code changes were announced, and all phone lines and mobile telephones of officials working on the budget were monitored - and apparently are monitored every year — at least a month before the annual budget presentation, the Business Standard reported. The level of secrecy is so high that not only is Finance Minister Pranab Mukherjee precluded from taking his budget speech home, 1 but all employees also are locked in approximately three weeks before the presentation of the budget, which is printed in the basement of the North Block.

Changing from common law to civil law, in which tax rates will be fixed, alleviates much of the intrigue surrounding the annual finance bill. "Intrigue": Isn't that a great word for lack of transparency?

The transparency process would presumably start with the introduction of the DTC. Fixed rates, under civil law, would mean that all that secrecy and prevention of information leaks would disappear. I can't see that happening in the India I know and love: Far too many people would lose money, not having inside information about the annual changes.

Presumably, once the DTC and the goods and services tax are in place, the Finance Ministry would then adopt law changes, with few procedural changes, as the only matters showing up in the annual Finance Bill. It's not going to happen soon. The Centre for Budget and Governance Accountability in 2008 placed India at number 58 in its survey of 85 countries using the yearly budget process. India simply has never provided anything but incomplete information on the budget to its citizens.

The Right to Information Act is projected for inception after both the DTC and the goods and services tax are in place. I think it's going to take a decade or longer for all of this to happen.

And speaking of the GST, the June 4 Business Standard presented a real pickle that the central government seems to have dilled itself into: Part of the program in development of the GST tax involves the establishment of a council of finance ministers from each of the states to work solely on matters of the GST. The central government proposed this council as a "disciplinary body" to make decisions binding on the whole nation regarding the GST, so that no state deviates from the proposed GST regime. This body would be made part of the country's constitution. An approval from a majority of states would be required for changing the agreed principles of the GST as a way of accommodating states' fears regarding the GST. Now the central government is having second thoughts, saying it wants veto power over this council because it fears the distinct possibility that the states could get together and gang up on the central government, forcing change. Wow, only in India, the world's largest democracy with a bureaucratic speed of a snail's pace, can something as bizarre as this take place!

The Business Standard also recently brought up the likelihood of thin capitalization rules being incorporated within the DTC. While this was poorly worded, as part of the previously written documentation (and just another reason why I am skeptical about that promise of a quick reintroduction of the DTC), it does tend to make sense, as major economic countries already have thin capitalization rules in effect, limiting the amount of interest that can be deducted in profit calculations, in which there is thought to be too high a portion of funds entering a company as debt rather than as capital.

"A committee, headed by a director general of income tax, was asked to frame thin capitalization rules. It has submitted its report. The rules are seen more as a mechanism for checking tax avoidance rather than revenue generation," said a Finance Ministry official, on condition of anonymity. Of course the person responsible for this news leak is anonymous — he'd be in deep trouble with the law violators, who are likely to be sizable in number.

In India, the Foreign Investment Promotion Board (FIPB) has defined the debt-to-equity ratio limit for the automatic investment route in various sectors. However, companies can always go for a higher debt-toequity ratio after getting approval from the FIPB. Moreover, the FIPB norms are only for checking foreign investment; this does not apply to domestic investors. Thin capitalization rules will apply to investments from all sources.

Special Economic Zones

While the revised DTC allows existing entities in existing special economic zones (SEZs) to continue operating and receiving SEZ entitlements, the Finance Ministry's decision that the companies in the zones will henceforth be subject to the minimum alternate tax of 2 percent of the gross value of its assets as a final tax negates the tax advantages of starting up in a zone in the first place. This has been a real juggling of tax balls, as the Ministry of Commerce has argued for tax on book profits instead. Commerce has formally written to the Department of Revenue of the Finance Ministry, airing its grievances, according to the Business Standard. I honestly wonder whether they'll get a response.

The revised DTC draft would seriously affect the biggest, most profitable of the SEZs, such as the Mundra Port SEZ in Gujarat, which is the region of fastest economic growth in India, as well as the Reliance Group SEZs, which are the biggest of the big enterprises in India. These guys don't want to pay taxes. They're going to, but not as much as the Finance Ministry would like them to. Let's face it, the statistical information is on the side of the Finance Ministry. Last year's Indian export market is higher than the 2010 export market, year-on-year, thus far. And yet, in the 111 most successful zones, exports are up a staggering 123 percent, according to media reports. In many cases, businesses simply moved ‘‘across town'' to go into an SEZ and get a great tax break. Tax Collections

The Finance Ministry is speaking with more authority lately because tax collections are booming in India right now. Indirect tax collections are up 43 percent, April through June, year-on-year. This amounts to INR 56,930 crore. Direct tax collections are also up, with personal income tax collections up by 15 percent, yearon- year to INR 66,675 crore, and a corporate collection increase of 21.65 percent for the same period, totaling INR 43,439 crore.

The Business Standard said unnamed sources attributed higher indirect tax collections to withdrawal of budget stimulus measures, the economic recovery, and, interestingly, the rising prices of crude oil in the international market, which contributed to a higher collection from Customs, as power needs also seem to be soaring.

Call 888.916.7070 or email info@trustmakers.com

By Laurence E. Lipsher

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