Tax System in India

Tax System in IndiaIndia has a well developed taxation structure. The tax system in India is mainly a three tier system which is based between the Central, State Governments and the local government organizations. In most cases, these local bodies include the local councils and the municipalities.

According to the Constitution of India, the government has the right to levy taxes on individuals and organizations. However, the constitution states that no one has the right to levy or charge taxes except the authority of law. Whatever tax is being charged has to be backed by the law passed by the legislature or the parliament.

The main body which is responsible for the collection of taxes is the Central Board of Direct Taxes (CBDT). It is a part of the Department of Revenue under the Ministry of Finance of the Indian government. The CBDT functions as per the Central Board of Revenue Act of 1963.

Types of direct taxes

Usually, the Central Government levies taxes on income, central excise duties, services taxes and various other types of direct taxes. Some of the various forms of direct taxes are:

Corporate Income taxes: According to the Income Tax Act, the companies and business organizations in India are taxed on the income from their worldwide transactions. In case of non resident business organizations, tax is levied on the income which is earned from their business transactions in India or any other Indian sources. In case of the resident or domestic organizations, a tax of 35 % and a 2.5 % surcharge is levied. In case of foreign corporate organizations, a basic tax rate of 40 % and 2.5 % surcharge is levied. In addition to these, 2% of education cess is also charged on the tax amount. In case the net profit becomes more than $ 33333, the organizations have to pay an additional 1 % as wealth tax.

Personal Income Tax: The Central Government levies the Personal Income Tax. It is administered and supervised by the Central Board of Direct taxes as per the provisions of the Income Tax Act. The personal income tax rates are as follows:

0-100,000- No tax needed 1, 00,000-1, 50,000- 10 % 1, 50,000-2, 50,000- 20 % 2,50,000 and above- 30 %

If the personal income becomes more than INR 8, 50,000, a surcharge of 10 % of the total tax amount is levied.

Some adjustments have been made in the recent budget about the rates of tax on the

personal income. The threshold limit has been increased by INR 10,000 which gives the assessee a tax relief Rs. 1,000. If the assessee is a woman, the threshold limit will be increased to Rs.145, 000 from Rs 135,000 while in case of senior citizens and the aged, the threshold limit has been increased to Rs 195,000 from Rs.185, 000. This will give the assessee a tax relief of Rs 2000. Under the section 80D, the deduction of medical insurance premium has been increased to a maximum limit of Rs 15,000 while for senior citizens, it has been increased to a maximum of Rs.20, 000.

Capital Gains Tax: The central government also charges tax on the capital gains that is derived from the sale of the assets. There are a number of provisions like:

The Long-term Capital Gains Tax is charged if:

The capital assets are kept for more than three years If the securities and shares are listed under any recognized Indian stock exchange.

In case of the long term capital gains, they are taxed at a basic rate of 20 %. Normal corporate income tax rates are applicable for short term capital gains. 10 % tax is levied on the short term capital gains that take place from the transfer of the units of mutual funds and equity shares.

In case of the short term and long term capital losses, they are lowed to be carried forward for 8 consecutive years.

Types of indirect taxes

Excise Duty: The central government levies excise duty under the Central Excise act of 1944 and the Central Excise Tariff Act of 1985. In most cases, around 16% excise duty is charged and in some cases, an additional excise duty of around 8 % is also charged. Due to the recent budget amendments, an educational cess of around 2 % is also charged.

In the recent budget, a number of tax exemptions have been initiated. Tax relied has been created in sectors which create jobs like small scale industries, cottage industries, food processing sectors, bio diesel and so on. In order to provide access of electricity and purified water, the water plans and purification technology sectors are also exempt from tax. Excise duty has been increased by around 5 % on cigarettes and other tobacco products.

Customs Duty: Customs duty in India falls under the Customs Act 1962 and Customs Tariff Act of 1975. Usually, the goods that are imported to the country are charged customs duty along with educational cess. For industrial goods, the rate has been slashed to 15%. The customs duty is evaluated on the value of the transaction of the goods.

The Central Board of Excise and Customs under the Ministry of Finance manages the customs duty process in the country.

Service Tax: Usually, 10 % service tax is levied on various services that are provided in

the country. In the recent budget, the tax exemption limit in case of the small service providers has been raised to Rs.800, 000 from Rs.400, 000. Tax relief has also been provided to the services of the Resident Welfare Associations whose members contribute monthly Rs 3000 for the services.

Types of state taxes

Apart from the central taxes, the states also levy taxes on various good and services. Some of the taxes are:

Sales Tax/VAT: In most cases, sales taxes are charged on the sale of movable goods. In most of the states, from April 1, 2005, the sales taxes have been replaced with Value Added Tax (VAT). In case of VAT, taxes are only levied on the goods and not the services. VAT comprises 4 slabs:

0% for essential commodities 1% levied on bullion and valuable stones 4% on industrial inputs and capital goods of mass consumption All other items 12.5%

The VAT rates of petroleum tobacco, liquor and so on are higher and differ from state to state.

In addition, there are some other state and local taxes that are applicable. They are:

Octroi/entry tax Stamp duty on asset transfer Property/building tax Agriculture income tax

Investor considerations

· Resident taxpayers are taxed on their worldwide income.

· Nonresident taxpayers are taxed only on income received in India or on income arising (or deemed to arise) in India.

· Corporate income is taxed both at corporate level and to shareholders upon distribution as dividends.

· The accounting year for tax purposes must end on March 31.

· Substance prevails over form if form is misused.

· Advance rulings for transactions involving nonresidents have been introduced.

· Double taxation relief is offered to residents through credits under the Income Tax Act and under the tax treaties.

Principal Taxes

The principal taxes are as follows.

1. Taxes on income:a. Income tax:b. Agricultural income tax (levied only by states);c. Interest tax (applicable to banking and financial companies).

2. Taxes on transactions:a. Local sales tax (levied only by states);b. Central sales tax;c. Excise duty;d. Customs duty;e. Stamp duty;f. Gift tax;g. Expenditure tax.

3. Taxes on property:Wealth tax;Property tax.

Direct and indirect tax burdenThe central budget for 1995/96 anticipates a total revenue

collection of Rs 1,037.62 billion, including revenue from the sources

Revenue Collection, 1995 / 96

Rs billions Percentage

Direct taxes 205.42 21.85

Income tax:

Companies 155.00

Others 39.41

Interest tax 10.00

Wealth tax 0.90

Gift tax and others 0.11

Indirect taxes 734.86 78.15

Customs duty 295.00

Excise duty 427.80

Others taxes and duties 12.06

940.28 100.00

Tax Quarantees

There are no tax guarantees in India.

LEGISLATIVE FRAMEWORK

Statute law

The law relating to income tax is contained in the Income Tax Act 1961. There are specific statutes for other taxes. Central tax statutes are passed by the central tax statutes are passed by the central Parliament and state tax statutes by the state assemblies. Tax rates and duties are reviewed annually when budgets are presented. Amendments to the statutes are made through the annual Finance Acts or specific Amendment Acts almost every year. Although amendments are usually prospective, retroactive amendments are permitted. Tax adm9inistrators have no authority to alter legislation but are empowered by the statutes to make rules to carry out the provisions of law.

Case law

Case law is a significant factor in the interpretation of the law. High Court decisions are binding on subordinate appellate authorities of the state over which the concerned High Court has jurisdiction, and they are persuasive for appellate authorities of other states. Supreme Court decisions are binding on all appellate authorities and assessing officers. Memorandums explaining the provisions of the law and the amendments that were place before the legislature when the law or amendments were introduced have often been referred to by Indian courts in interpreting legislation.

Antiavoidance

No general antiavoidance provisions are pervasively applicable to all situations. However, individual provisions apply to specific transactions. In certain cases, where the Tax authorities have been able to prove that the primary reason behind the action was to avoid tax, the courts have looked through the scheme and determined the issue on substance. Provisions for advance ruling with respect to transactions involving nonresidents have been introduced.

Form versus substance

In the absence of a challenge, form is respected. But substance takes precedence over form where the purpose of using the form is to defeat the intent of the legislation.

Clearance procedures

Advance clearance is required for certain specific transactions such as an amalgamation in which the amalgamated company seeks to carry forward and set off the unabsorbed losses and depreciation of the amalgamating company, transfer of immovable property above a specified price in designated areas, creation of a charge on certain assets, and remittances outside India. Expatriates who have been in India continuously for more than 120 days must also obtain a tax clearance before they depart.

Provisions for advance rulings on transactions involving nonresidents have been incorporated into the law through the Finance Act 1993. An advance ruling is determined by an authority constituted by the central government. The advance ruling is determined by an authority constituted by the central government. The advance ruling is binding only with respect to the applicant that has sought it and the particular transaction. It is also binding on the Income Tax authorities with jurisdiction over the applicant.

INCOME TAX Concepts of income taxation

The income tax system in India is unitary. Income less permissible expenses from all sources (other than long-term capital gains) of each tax payer s aggregated and subject to tax at a flat rate in the case of

companies and partnership firms and at progressives rates in the case of other taxpayers. Long-term capital gains are concessionally

taxed at lower rates.

Residents are taxed on their worldwide income. Subject to treaty exemptions, nonresidents are taxed only on income that is received

in India or that arises in India or is deemed to arise in India.

India follows the "classical system," under which corporate income is taxed both to the corporation and upon distribution to the

shareholders as dividends. However, dividends received by one domestic company from another domestic company are not taxed in

the hands of the recipient company to the extent it distributes the dividends to its shareholders within the time allowed for filing its tax

return.

Geographical source of income

Generally, income arises in India if it becomes due in India. This depends on where the income-producing asset is located, where the services giving rise to the income are performed, where the sale is effected, and other considerations. In addition, the Income Tax At

specifically mentions that the following income is deemed to arise in India.

1. Income arising directly or indirectly through or from any business connection in India; through or from any property, asset or source of income in India; or through the transfer of a capital asset situated in

India.2. Salaries earned in India, even if paid outside India.3. Dividends paid by Indian companies outside India.

4. Interest, royalties or technical service fees payable by the government.

5. Interest, royalties or technical service fees payable by persons other than the government unless the funds borrowed, the patent,

the technical information, etc., are utilized in a business outside India or for earning income from a source outside India.

These categories of deemed Indian-source income are subject to the following qualifications.

1. In the case of a business with some operations not performed in India, the income deemed to arise in India is only that part or the

income reasonably attributable to the operations performed in India.2. In the case of nonresidents, no income is deemed to arise in India

from operations that are confined to the following:a. Purchase of goods in India for the purpose of export;

b. Collection of news for transmission out of India in the case of a nonresident publisher of newspapers, magazines or journals;

c. Shooting of cinematographic films in India by foreigners and nonresident firms or companies not having any partner or shareholder who is an Indian citizen or Indian resent; and

d. Transfer of rights in computers and software by a nonresident manufacturer along with computer-based equipment under an

approves scheme of the government of India, against lump-sum payment.

Classes of taxpayer

The income tax law classifies taxpayers as follows.

1. Companies.2. Firms (partnerships).

3. Associations of persons or bodies of individuals.

4. Individuals.5. Hindu undivided families.

6. Local authorities (municipal bodies).7. Artificial juridical persons.

Taxable income

Income is classified into the following five heads, depending on its source.

1. Income from salaries.2. Income from house properties.

3. Profits and gains from business or profession.4. Capital gains.

5. Income from other sources.

Specific provisions govern the computation of net income from each source. Gains on the transfer of capital assets (other than long-term capital gains) are aggregated with the net income from other heads to arrive at the total taxable income. Longer-term gains are taxed at

lower rates.

Tax year

For tax year-end must be March 31. This is known as the previous year. The fiscal year, starting on the April 1 immediately following the previous year, is known as the corresponding assessment year. The taxable income of the previous year is subject to tax at the rates in

force for the corresponding assessment year.

Tax-free zones

To encourage foreign exchange earnings, the following free-trade zones in which industrial undertakings can be set up for manufacture

and processing for exports, have been notified.

1. Santa Cruz Electronics Export Processing Zone (SEEPZ). Mumbai (Bombay), Maharashtra.

2. Kandala Free Trade Zone (KAFTZ), Gujrat.3. Falta Export Processing Zone (FEPZ), West Bengal.

4. Cochin Export Processing Zone (CEPZ), Kerala.5. NOIDA Export Processing Zone (NEPZ), Uttar Pradesh (bordering

New Delhi).6. Madras Export Processing Zone (MEPZ), Tamil Nadu.

7. Surat Export Processing Zone, Gujrat.8. Vishakhapatnam Export Processing Zone, Andhra Pradesh.

Industrial undertakings set up in these zones are exempt from income tax for any five consecutive years during the first eight years of their

operation, provided they export at least 75 percent of their total turnover of each year. Similar exemption is also granted to 100

percent export-oriented undertakings (EOUs) set up elsewhere and to units set up in notified Software Technology Parks (STPs) and

Electronic Hardware Technology Parks (EHTPs). Other exporters also enjoy specified deductions for export profits in computing their

taxable income.

Tax holidays

Both new industrial undertakings located in the specified "backward states" or districts and new industrial undertakings set up for

generation or generation and distribution of power are entitled to full tax exemption of profits for the first five years of operation, followed by partial tax exemption of 30 percent (for companies) of the profits of the next five years. Similar exemption is available to enterprises carrying on the business of developing, maintaining and operating a

notified "infrastructure facility" with respect to profits land gains spread over any 10 consecutive years falling within the first 12 years.

CAPITAL TAXATION

Companies

No tax is payable on the basis of value of the company upon incorporation or issue of shares. However, annual wealth tax is

payable at 1 percent on the value of specified assets minus specified debts to the extent the value exceeds in aggregate Rs 1.5 million.

Individuals

Individuals are liable to annual wealth tax at 1 percent on the value of net wealth (specified assets minus specified debts) in excess of Rs 1.5

million. Individuals are also liable for donor-based gift tax upon transfer of assets made through gifts.

INTERNATIONAL ASPECTSForeign operations

Residents are subject to tax on their worldwide income. They are allowed a tax credit up to the amount of Indian income tax for foreign income taxes paid on foreign-source income. Double taxation is also

avoided through treaty provisions.

Nonresidents are not subject to tax on income that arises outside India and is received outside India (unless it is deemed to arise in India as described under "Geographical source of income" above).

Nonresidents are not allowed a foreign tax credit.

International financial center

There are no concessions in the Indian tax laws encouraging foreign companies to use India as a location for a financial center.

TAXATION OF FOREIGN


· Companies resident in India are taxed on worldwide income, whether or not remitted to India.

· Foreign branch losses can b3e set off against domestic profits.

· Income of foreign affiliates is includable in the Indian company's taxable income only when distributed as dividends.

· Double taxation relief is granted to residents by the credit methods.

· To the extent they cannot be credited, foreign taxes are lost permanently.

Taxation of foreign income

Companies resident in India are subject to Indian tax on their income, generally on an accrual basis, from all sources inside or outside India and whether or not remitted to India.

Branch income

The income of all foreign branches is taxed in India as part of the Indian company's worldwide taxable income. Similarly, the losses of all foreign branches are deductible in computing the worldwide taxable income. In computing the income or loss of a foreign branch, a deduction is generally allowed for all expenses incurred wholly and exclusively for the purpose of the business that are not of a capital or personal nature. Income is taxed whether or not repatriated. If the branch income incurs tax in the foreign country, credit is given in India to the extent of the lesser of the foreign tax paid or the Indian tax on the foreign income, either unilaterally or under treaty.

Foreign subsidiary income

Dividends of foreign subsidiaries when declared (and interim dividends when they are made unconditionally available) are included in the worldwide taxable income of the Indian company. Profits not distributed by the foreign subsidiary are not taxed in the hands of the Indian company. Treaties often provide for lower foreign withholding tax. No credit is given for underlying tax paid by the foreign subsidiary.

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Liquidation proceeds

A distribution to an Indian company by a foreign subsidiary upon its liquidation is treated as dividends to the extent it is attributable to accumulated profits up to the date of liquidation. The balance is treated as a return of capital and taken into account in determining the capital gain or loss on the shares held.

Dividends

See "Foreign subsidiary income" above for treatment of dividends>

Interest

Interest from foreign subsidiaries is fully taxable in the hands of the Indian company, with credit allowed for foreign tax withheld or paid, up to the Indian tax on the interest.

Royalties and fees for technical or professional services

Indian companies and other residents are allowed a deduction equal to 50 percent of the royalties and fees for technical and professional services received in convertible foreign exchange from foreign governments or any foreign enterprise for granting the use of patents, providing technical or professional services abroad, etc. The excess and any other royalties and fees for technical services are taxable in full, subject to credit for the foreign tax withheld or paid up to a maximum of the Indian tax on the royalty or fees.

Foreign exchange gains and losses

Profits and losses of foreign branches, royalties and fees for technical services, and interest (other than interest on securities) arising in foreign currency are translated for inclusion in the worldwide taxable income of the Indian company at the relevant telegraphic transfer buying rate. Dividends from foreign subsidiaries, capital gains and interest on securities are also translated the relevant telegraphic

transfer buying rate. Revenue gains or losses in exchange are included or deducted in computing the worldwide taxable income.

PARTERSHIPAND JOINT VENTUREInvestor considerations

· A partnership is an entity for tax purposes.

· Double taxation can be avoided where the partnership is evidenced by a deed specifying the individual shares of partners.

· A joint venture is not well defined in the law.

· Unless incorporated or established as a firm as evidenced by a deed, joint ventures maybe taxed like association of persons, sometimes at maximum marginal rates.

Partnerships

A partnership is a common vehicle in India for carrying on business activities (particularly trading) on a small or medium scale. A profession is generally carried on through a partnership. There is no restriction on a company's participation in a partnership, but this is rate in practice.

Entity or conduit

Under the general law a partnership is not a separate entity distinct from the partners, but for tax purposes a partnership is an entity. Double taxation is avoided in the manner described below.

Taxable income

In the case of a partnership evidenced by a deed in which the individual shares of the partners are specified, the taxable income of the partnership is computed in the same manner as that a company. Salary, bonuses, commissions, and other remuneration payable to working partners and interest payable to partners according to the partnership deed are deductible to the specified limits in computing the partnership's taxable income and included in the taxable income of the applicable partner.

The partnership pays tax on the balance profits at 40 percent (30 percent on long-term capital gains). (It is proposed to reduce the capital gains tax to 20 percent.) The balance profits are not taxed in the hands of the partners.

A partnership not evidenced by a deed in which the shares of the individual partners are specified is taxed like a joint







venture.

Taxation of foreign partners

A foreign partner is taxed in the same manner as an Indian partner. Membership of a nonresident company in an Indian partnership, if permitted by the Reserve Bank of India, would create a permanent establishment.

The tax treaties generally do not specifically address partnerships. However, the permanent establishment and business profits articles are relevant to nonresident corporate partners, while the independent personal services articles are relevant to nonresident individual partners. The article on elimination of double taxation enables nonresident partners to claim relief for double taxation in their country of residence.

JOINT VENTURES

Entity or conduit

A joint venture is not well defied in Indian law. If it is established as a partnership evidenced by a deed specifying the shares of the partners or incorporated as a company whose shares are held by two or more parties, it is taxed in accordance with its legal form (i.e., as a partnership or a company). Otherwise, a joint venture may be treated as an association of persons for Indian tax purposes, subject, in some cases, to a higher tax rate as explained below.

If the shares of the venturers are determinate and known since the inception of the venture, the taxable income of the venture is subject

to tax at the slab rates applicable to individuals, except in the following cases.

1. If the taxable income of any venturer (excluding that from the venture exceeds Rs 40,000, the taxable income of the venture is subject to tax a flat rate of 40 percent.2. If any venturer is a company liable to tax at a rate higher than 40 percent, that portion of the venture's income equal to the share of the venturer company is subject to tax at the rate applicable to the venturer company, and the balance is subject to tax at 40 percent.

If the shares of the ventueres are indeterminate or unknown on the date of formation or any time thereafter, the taxable income of the venture is subject to tax at 40 percent unless any of the venturers is a company liable to tax at a rate higher than 40 percent, in which case the entire taxable income of the venture is subject to tax at the higher rate applicable to the venturer company.

Under certain circumstances, the venturer's pretax allocated share from the joint venture is aggregated with other income to determine the tax payable on the other income. This has the effect of pushing up the other income to higher tax brackets except in the case of companies, which are subject to a flat rate.

Taxable income

The taxable income of a venture is determined in the same manner as in a company. Interest and remuneration payable to the venturers are treated as profit participations and added back in arriving at the venture's taxable income.

Taxation of foreign venturer

A foreign venturer is taxed in the same manner as Indian venturer, subject to the higher tax rate in the case of a nonresident corporate venturer.

TAXATION OF SHAREHOLDERS


· Dividends received by one domestic company from another are deductible if the recipient distributes them to its shareholders within a specified period.

· Taxable capital gains arise on the transfer of shares in Indian companies

· Branch losses cannot be carried forward upon incorporation.

· No capital gains are computed in amalgamation or transfer of assets between a holding company and its wholly owned subsidiary if specified conditions are fulfilled.

· Transfer abroad of shares in foreign companies that hold shares in Indian companies is not a taxable even in India.

· Distributions upon liquidation can give rise to dividends and capital gains.

· Step-up in tax basis of assets acquired via share acquisition is not permitted.

DOMESTIC SHAREHOLDERS

Dividends

Dividends received by domestic shareholders, both corporate and noncorporate, are includable in gross income under the head "income from other sources," grossed up by the tax withheld. Individuals are permitted a deduction for gross dividends received from Indian companies as well as certain other types of income, such as interest from banks and dividends from cooperative societies, up to a combined maximum of Rs 13,000. Domestic companies are permitted to deduct dividends received from other domestic companies to the extent they distribute these dividends to their shareholders within a specified time. As an antiavoidance measure, advances and loans granted by closely held companies to substantial shareholders and certain concerns are treated as dividends, stock dividends (i.e., bonus shares) are not table.

India follows the classical system of corporate taxation. Shareholders get full credit for tax withheld from the dividends against their tax liability, but not for underlying tax paid by the company on its profits. Resident shareholders get credit for







foreign tax withheld or paid with respect to foreign dividends up to a maximum of the Indian tax on the doubly taxed income. Nonresident Indians making certain investments (including those in shares in Indian companies) in convertible foreign exchange can elect to treat the

income and gains from the investments as a separate block liable to tax at 20 percent.

Capital gains

Capital gains, which may be long-term or short-term depending on whether the shares are held for more or less than one year, are computed and taxed in the manner discussed under "Capita gains". Special considerations may apply to the valuation of bonus shares and sale or rights, depending on the circumstances of the case.

FOREIGN SHAREHOLDERS

Dividends

Taxes are withheld at source from dividends paid to foreign shareholders at the rates indicated in Appendix IV. The general withholding rate from dividends to foreign companies is 20 percent, which is often lowered by treaties for both portfolio and substantial holdings. A lower rate of 10 percent applies to dividends on units of Indian mutual funds purchased in foreign currency by specified overseas financial organizations and, in the case of nonresidents, dividends from shares issued abroad by Indian companies under approved schemes. Some treaties provide for credit of underlying corporate tax, in addition to tax withheld, in the country of residence.

Capital gains

Net gain is computed in the same manner as in the case of residents and subject to treaty provisions, tax is withheld at the rates given in Appendix IV. The rate is 55 percent on short-term gains in the case of foreign companies. For long-term gains, the rate is 20 percent for companies as well as for individuals. Special rules apply for the computation of capital gains in the case of foreign institutional investors.

REORGANIZATIONS

Incorporation

The transfer of a business as a contribution-in-kind to the capital of a company is treated as a sale, and the gain thereon (i.e., the difference between the value of the shares or cash receivable and value of the business transferred) I subject tot ax as capital gains in the

assessment of the transfer or. The unabsorbed loses and depreciation of the transferor are not carried over the transferee. (However, there is no tax on capital gains in the case of certain amalgamations and transfers between a holding company and its 100 percent subsidiary - see below.)

Merger or amalgamation

No capital gains are computed for a transferor company or its sharer holders on the transfer of a business under a scheme of amalgamation, provided the following conditions are satisfied.

1. All assets of the amalgamating company are transferred to the amalgamated company.2. All liabilities of the amalgamating company are transferred to the amalgamated company.3. Ninety percent of the shareholders of the amalgamating company become shareholders in the amalgamated company.4. The amalgamated company is an Indian company.

Where the above conditions are fulfilled, the unabsorbed losses and depreciation of the amalgamating company can be carried over by the amalgamated company if the scheme is approved by the prescribed authority.

Where the merger or amalgamation does not fulfill the above conditions, the general rule mentioned under "Incorporation" above applies. In such a case, if the value of the shares in the transferee company distributed to a shareholder of the transferor company, the excess is subject to tax in the shareholder's hands as capital gains.

Transfer abroad of shares in an Indian company by one nonresident to another is taxable event in India. However, the transfer of such shares by one foreign company to another in a scheme of amalgamation is exempt from capital gains tax if specified conditions are satisfied.

Reorganization

No capital gain is computed on the transfer of assets to or from a wholly owned subsidiary, provided this relationship continues for at least eight years and the transferee company is an Indian company (unless capital assets taken over are converted into inventory within eight years of transfer). Subject to this and the exemption for amalgamations fulfilling specified conditions mentioned above, all other reorganizations, e.g., spin-offs of divisions, mergers not satisfying the specified conditions, result in taxable capital gains both

at the corporate level for transfer of business or assets and at the shareholder level if shares are exchanged. However, a mere stock split or stock consolidation is not regarded as disposition for tax purposes. Instead, the total cost of the shares previously held is simply allocated over the larger or smaller number of shares received.

Liquidation

A company continues to be liable to tax on profits and capital gains arising after commencement of liquidation until the liquidation is finally terminated with distribution of all assets. Expenses incurred after the company has ceased business are generally not deductible.

Distribution to shareholders is treated as a dividend to the extent of accumulated profits. The balance of the distribution is regarded as a return of capital and taken into account in computing capital gains on the shares held.

ACQUISITIONS

Asset acquisition

In an asset acquisition at arm's length, the cost of the purchased assets in the hands of the purchaser is equivalent to the total amount paid (except an amalgamation in which the conditions mentioned earlier are satisfied or a transfer between a holding company and its wholly owned subsidiary, provided in either case the transferee is an Indian company). However, the purchaser cannot amortize the cost of goodwill. If the company's acquired through a purchase of assets rather than shares, the unabsorbed losses, depreciation, etc., of the company cannot be carried forward by the purchaser. The company whose assets are acquired recognizes a gain or loss depending on the nature of assets (i.e, capital gain or loss where the asset transferred is a current asset). Capital gains are recognized on the transfer of goodwill.

A significant point the seller must keep in mind is the recapture of certain capital allowances allowed earlier if the capital assets are transferred within eight years of acquisition. Also important is the high stamp duty on the transfer of immovable property. Depending on the facts, interest on borrowings for acquisition or on the unpaid purchase price of assets is generally deductible where the business is carried on.

Share acquisition

In a share acquisition, the selling shareholder is taxed on capital gains on the shares transferred. The price paid constitutes the purchase price of the shares in the hands of the purchaser. There is no step-up in the value of the company's assets upon the change of control to reflect the purchase price. The unabsorbed losses, depreciation and capital allowances of the company continue to be carried forward up their normal statutory limits because its corporate existence is unaffected. Interest on borrowings to acquire shares is deductible from dividends income, except that tax is withheld on the basis of gross dividends in the case of foreign companies.

Buyer and seller

Foreign investment in India is possible only with the permission of the Reserve Bank of India. While foreign buyers may be permitted to participate in the share capital of an Indian company up to a specified extent, they are not normally permitted to make a straight purchaser of assets of an Indian business that would make it virtually a branch.

He acquisition and sale of shares in an Indian company have tax implications already explained, but the transfer of shares abroad of a foreign company that holds shares in an Indian company is not a taxable event in India. However, an Indian company with foreign holdings may acquire assets or shares, and the consequences indicated earlier will follow.

While the relative considerations of the buyer and seller will depend on the facts of each case, the buyer would weight the possibility of increasing the asset base through asset acquisition against high stamp duty, loss of unabsorbed losses and depreciation, and recapture of past capital allowances. The seller would try to maximize capital gains and might prefer to avoid all corporate involvement. On balance, acquisition of shares is more common.

See Appendix XIV for other points that should be considered by investors, their legal counsel and their accountants before acquiring a business enterprise in India.

TAX TREATIES


· India has a growing network of treaties.

· Any applicable treaty or domestic law, whichever is more beneficial applies.

· The treaty definition of "permanent establishment" and taxation of only such business profits as are attributable

thereto limit exposure otherwise possible under domestic law.

· Lower withholding rates are available for certain dividends, interest, royalties, land fees for technical services.

· Generally, Indian treaties do not contain a separate article to prevent treaty shopping.

Tax treaty policy

The government of India continues its policy to expand the network of international tax treaties and renegotiate existing treaties. Appendix V lists the treaties in force. The air of the treaties is to relieve double taxation, curb tax evasion, and attract know-how and technology. As a developing country, India seeks inclusion of tax-sparing provisions in its treaties

with developed counties, and this has often been a stumbling block in concluding treaties (e.g., with the United States).

India also seeks to retian the right to tax royalties land fees for technical services from Indian sources, although in many cases at withholding rates lower than the general rate. Most treaties are comprehensive, but some treaties are limited to

aircraft and / or shipping.

The later treaties tend to follow the U.N. Model Convention. Any applicable tax treaty or domestic law, whichever is more

beneficial, applies.

Withholding taxes

Under domestic law, the rate of withholding tax is 20 percent from dividends and taxable interest on foreign currency loans payable to nonresidents. A lower rate of 10 percent applies in

certain cases (see Appendix IV). The general rate of withholding tax on royalties and fees for technical services

payable to foreign companies under agreements approved by the government or in accordance with declared industrial

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Many treaties provide a reduced rate of withholding from dividends, interest, royalties, and fees for technical services, provided they are not effectively connected with a permanent

establishment. Generally, there is no treaty reduction for royalties, fees for technical services and interest in excess of

an arm's-length charge, and the lower with holding rates usually apply only in the case of beneficial ownership.

Appendix IV lists the withholding tax rates on dividends, interest, royalties, and fees for technical services. Fiscal authorities are bound by the treaty withholding rates.

Permanent Establishment

The concept of permanent establishment tends in most cases to follow, with modifications, the U.N. Model Treaty. Fees for technical services are generally dealt with separately under a specific article in which India retains the right to withhold tax. In many cases, "permanent establishment" includes a building

site or construction, installation or assembly project, or supervisory activities in connection therewith where the site,

project or supervisory activity continues for more than a prescribed period (usually six months) or, in certain cases, if the charge payable for the project or supervisory activities

exceeds a specified percentage of the sale price of equipment. The treaties provide specific guidelines as to the type of

agency relationships that constitute a permanent establishment. Normally, the use of storage or display

facilities, the maintenance of goods for processing by another enterprise or the maintenance of a fixed place of business

solely for purchasing goods or collecting information does not constitute a permanent establishment.

Under domestic law, a nonresident is taxed on all income that is received in India or that arises or is deemed to arise in India.

This exposure is limited by the definition of permanent establishment in the treaties and by the fact that only the

business profits attributable to the permanent establishment in the treaties and by the fact that only the business profits attributable to the permanent establishment are subject to Indian tax. The treaties do not include a force-of-attraction clause, although income from interest, dividends, royalties,

and fees for technical services may be taxed as business profits if they are effectively connected with a permanent

establishment. Some recent treaties also subject to tax the sale of goods or other business activities in India of the same

or a similar kind as those sold or effected through the permanent establishment.

The attributable profits of a permanent establishment are generally determined as if it were an independent enterprise engaged in the same or similar activities under the same or

similar conditions. Some treaties protect domestic law, which limits the allowance of head office expenses.

Personal Services

The treaties generally distinguish between independent and dependent personal services. Independent personal services are taxable in the country of performance only if the person

rendering the services has a fixed base in the country or stays in that country for more than a prescribed number of days (usually 183 days, less in some cases). Dependent personal

services are generally exempt from tax in the country of performance if the employee is present in that country for 183

days or less, the remuneration is paid by or on behalf of an employer who is not resident in that country, and the

remuneration is not borne by a permanent establishment or fixed base that the employer may have in that country. A few agreements provide that the employer must a resident of the other contracting state. Generally, there is no upper limit on

the amount that may be exempt. The treaty rules substantially reduce the exposure a nonresident individual may otherwise

have under domestic law.

Aircraft and shipping

Most Indian treaties provide for reciprocal tax exemption of international aircraft profits. Most treaties provide tax

exemption up to 50 percent of the domestic tax on international shipping profits derived in the contracting state

by an enterprise of the other state. Some treaties provide for a reduction in the percentage five years after the treaty comes

into force. Several recent treaties define "aircraft and shipping income" to include income from specified incidental

operations.

Elimination of double taxation

Indian treaties generally provide for the elimination of double taxation on Indian residents under the credit method, under which a credit is allowed from the Indian tax liability equal to

the lower of the foreign tax withheld or paid and the Indian tax on the doubly taxed income. For nonresidents liable to tax in

India, the treaties provide for relief in their country of residence in accordance with their laws, either by exemption

(with or without progression) or through credit against the tax liability in that country. Some treaties entitle foreign

companies holding a prescribed percentage of shares in an Indian company to claim a tax credit in their country of

residence for underlying taxes paid by the Indian company on their profits in India in addition to the withholding tax on

dividends. Certain Indian treaties provide for allowance of a tax-sparing credit by the other treaty partner.

Antiabuse of treaties

A common antiabuse provision is the precondition of beneficial ownership for taking advantage of lower with holing rates on

dividends, interest, royalties, and technical service fees. Generally, the treaties prohibit the application of lower

withholding rates on interest, royalties and fees for technical services in excess of the arm's-length charge if higher amounts

are agreed on due to special relationships. Associated enterprises are subject to tax adjustment if the transactions

differ from those that would have been made between independent enterprises.

The treaties do not generally contain any special antiabuse articles to deal with treaty shopping. However, a specific

article in the treaty with the United States seeks to prevent third-country residents from establishing a presence solely to

take advantage of the treaty.

Exchange of information

Most treaties provide that the competent authorities are to exchange such information as is necessary for carrying out the provision of the treaty and for preventing fraud or evasion of taxes. The treaties usually contain restrictions regarding the treatment and type of information that may be exchanged.

Competent authority / Mutual Agreement

The treaties generally provide that a resident of a contracting state may approach the competent authority in the country of

residence if it appears that the actions of Tax authorities result or will result in taxation at variance with the treaty, notwithstanding any other remedies that may be available

under the law. The competent authority will attempt to reach an agreement with its counterpart in the other country to

resolve the issue.

TAXATCORPORATE TAX SYSTEM

Corporations and shareholders

India follows the "classical" system: companies are taxed at flat rates and dividends distributed are included in the taxable income of

shareholders. However, a domestic company receiving dividends from another domestic company is entitled to deduct the amount of

dividends received to the extent of the dividends it distributes to its own shareholders before the due date for filing the return.

Individual shareholders are permitted to deduct dividends received from Indian companies to a specified extent. Tax is withheld from

dividends distributed, and shareholders get full credit for that amount against their tax liability, but they do not get credit for the underlying

corporate tax paid by the company. Residents receiving dividends from foreign companies get credit for foreign tax paid to the extent of the

extent of the Indian tax on the doubly taxed income, either unilaterally or under treaty.

Taxable entities

A "company" means an Indian company or a corporate body incorporated by or under the laws of a foreign country. A company is

treated as resident if its is an Indian company or if during the years the control and management of its affairs are situated wholly in India.

Territoriality

A resident company is taxed on its worldwide income. A nonresident company is taxed only on income that is received in India, arises in

India or is deemed to arise in India, subject, however, to treaty provisions.

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GROSS INCOME

Accounting period

The accounting period for tax purposes must end on March 31.

Accounting methods

Under the Indian Companies Act, accounting must be on an accrual basis, and this is adopted for tax purposes. Dividends are taxed in the

year in which they are declared, and capital gains are taxed in the year in which the capital asset is transferred. However, certain deductions, such as statutory dues, bonuses or commissions to employees, as well

as interest on borrowings from public financial institutions, are permitted only on a cash basis (however, they are allowed if paid

within the due date for filing the return), and deductions for contributions to approved retirements funds are permitted only on a

cash basis and if they are paid within the specified due dates

applicable to the funds. I is proposed under the Finance Bill 1996 that the rule for interest be applied to scheduled banks as well.

Business profits

Taxable profits are accounting profits as modified by specific statutory provisions (e.g., adjustment for nonallowable terms, allowances and

losses carried forward).

Inter company transactions

Generally, intercompany transactions are accorded the same tax treatment as transactions with unrelated parties if they are negotiated

at arm's length. However, note should be taken of the following.

1. In cases of payments to specified related parties, the assessing officer is empowered to disallow as much thereof as is considered excessive or unreasonable with respect to the fair market value,

legitimate business needs and benefits derived (there is no specific provision for corresponding adjustment in the hands of the payee).

2. Where, due to close connection with nonresident, the transaction produces less than ordinary profits to the resident, the assessing

officer can substitute reasonable profits for the profits shown.

3. Where by design an income-producing asset is transferred to a nonresident while the resident continues to have power to enjoy the

income or obtains the income in the guise of a loan or repayment of a loan, the income in the guise of a loan or repayment of a loan, the

income may be taxed in the hands of the transferor.

4. No capital gain or loss is recognized on transfer of capital assets between a company and its 100 percent subsidiary if the transferee is

an Indian company, provided the relationship continues for at least eight years.

5. The base for calculating depreciation remains unchanged in the case of transfer of depreciable assets between a company and its 100

percent subsidiary if the transferee is an Indian company, irrespective of the actual transfer price.

6. Advances or loans given by a closely held company to its shareholders are treated as dividends. A closely held company is a

private company, a company whose shares are not lasted on any stock

exchange in India or a company more than 50 percent (60 percent in the case of manufacturing companies) of whose shares are beneficially

held through out the year by other closely held companies.

Inventory valuation

Any method of inventory valuation that accords with sound commercial accounting principles can be followed for tax purposes, provided it is

adopted consistently at the beginning and end of the accounting periods over the years. Subjected to this general proposition, in

practice inventory is usually valued at (1) cost or (2) cost or market value, whichever is lower. For deterrnining cost, FIFO or the average-

cost methods is used.

Reserves for obsolescence cannot be deducted. Obsolete items are usually reflected by lower year-end values where the valuation is at

the lower of cost and market value.

Capital gains

Gains arising on the transfer of capital assets are subject to tax as capital gains. Capital assets include property of any kind, but exclude personal effects other than jewelry, inventories held for the purpose of

business and agricultural land situated more than eight kilometers from a town with a population of 10,000 or more. Capital gains arising

from the transfer of depreciable assets that form part of a "block of assets" are treated as short-term capital gains and computed by

deducting from the sale price the following amounts.

1. Written-down value of the block of assets at the beginning of the previous year.

2. Actual cost of assets falling within the particular block that were acquired during the previous year.

Capital gains on other assets are computed by deducting from the sale price the following amounts.

1. Actual cost of the asset.2. Cost of improvements made to the asset.

3. Expenditure incurred in connection with the transfer.

While computing capital gains from the transfer of shares and other specified securities held for more than one year and other assets held for more than three years (long-term capital gains), actual cost and

cost of improvement are to be increased by a specified inflation factor (with fair market value on April 1, 1981 as the base if the asset was

held from before than date).

In calculating capital gains on shares and debentures in Indian companies, nonresidents have the benefit of protection against falls in the value of the rupee vis-à-vis the foreign currency in which the asset

was acquired. However, in such cases, no indexation for inflation is available. Special rules and rates apply for the computation of gains

earned by approved foreign institutional investors.

Short tem capital gains are taxed at the same rate as other income. Long-term gains are taxed at 20 percent for individuals, 30 percent for

domestic companies and 20 percent for non domestic (i.e., foreign) companies. However, the rate is 10 percent on long-term capital gains from the transfer of units of Indian mutual funds purchased in foreign currency by specified overseas financial organizations and from the transfer by non-residents of shares or bonds issued abroad by Indian

companies under approved schemes. Concessional tax rates for computation of capital gains are applicable to approved foreign

institutional investors. Long -term capital gains income of venture capital funds or venture capital companies from the transfer of equity

shares of venture capital undertaking are wholly exempt from taxation.

No capital gains tax is assessed on the transfer of assets between a parent company and its 100 percent-owned subsidiary, provided this

relationship continues for at least eight years from the date of transfer and the capital asset is not converted by the transferee company as its

stock-in-trade (inventory) at the time of transfer. Also there is no capital gains tax on transfers in cases of specified amalgamations or

when buildings, land, and plant and machinery are sold upon the relocation of an industrial undertaking from an urban to a nonurban area if the sale proceeds are reinvested in similar assets in the new area within a specified period. Furthermore, no capital gains tax is

imposed on transfers abroad by one nonresident to another of shares or bonds issued abroad by Indian companies under specified schemes or on transfers of shares in Indian companies by one foreign company

to another in an amalgamation if at least 25 percent of the shareholders of the amalgamating company become shareholders of the amalgamated company and the transfer is exempt from capital gains tax in treatment of losses arising on transfer of capital assets.

Interest

Interest is taxable on an accrual basis. In the absence of any thin-capitalization rule, interest is never treated as dividends. Certain

interest received by nonresidents is exempt from tax, including the following.

1. Interest payable by industrial undertakings in India on Borrowings from approved foreign financial institutions.

2. Interest at approved rates on debts incurred in a foreign country for the purchase outside India of raw materials or machinery and

equipment.3. Interest on approved foreign currency loans from sources outside

India.4. Interest payable by Indian financial institutions or banks at approved

rates on borrowing from foreign sources.

Any other interest from foreign borrowings where the funds are utilized in a business in India is subject to tax, which is withheld at rates shown

in Appendix IV. A lower tax rate of 10 percent applies to interest on bonds issued abroad by Indian companies under approved schemes.

Intercompany dividends

A domestic company receiving dividends from another domestic company is entitled to deduct them when computing its taxable

income, to the extent covered by the dividends it distributes to its own shareholders before the due date for filing its return. Dividends

received by foreign companies from Indian companies are taxed at 20 percent or a lower treaty rate. A lower tax rate of 10 percent applies to

dividends in certain cases. Dividends received by a venture capital funds or company from venture capital undertakings are wholly

exempt from taxation.

Stock dividends

Bonus shares (stock dividends) are not taxed in the hands of the recipient shareholders.

Dividends-in-kind

Dividends-in-kind are virtually unknown. If received, they are taxed like ordinary dividends.

Royalties and service fees

Royalties and fees for technical services received by Indian companies from Indian concern are taxable in full. Fifty percent of royalties and fees for technical services received by Indian companies and other

residents in convertible foreign exchange from foreign governments or foreign concerns are exempt from tax.

Nontaxable Income

Nontaxable income items that may be received by companies include the following.

1. Interest on certain tax-free bonds.2. Agricultural income (but certain types are liable to agricultural

income tax levied by state governments).3. Certain interest received by nonresidents.

5. Payments made by an Indian company engaged in the business of operation of aircraft to a foreign enterprise in order to acquire an

aircraft of aircraft engine on lease, provided the agreement is approved by the central government.

6. Subsidies received by tea, rubber, coffee, and cardamom companies from their boards for replantation, replacement, rejuvenation, or

consolidation.7. Income of nonresident companies and nonresident news agencies

shooting cinermatographic films in India not having an Indian shareholder or partner.

8. Profits of new industrial undertakings set upon free-trade zones, Software / Hardware Technology Parks and 100 percent export-

oriented undertakings for five consecutive years during the first eight years.

It is proposed that interest income on foreign currency loans to industrial undertakings involved in the operation of ships or aircraft or in the construction and operation of rail system also be nontaxable.

For various other exemptions and full and partial deductions applicable to certain activities and circumstances, see "Capital gains" and "Intercompany dividends" above and "Other deductions" below.

DEDUCTIONS

Business Expenses

Generally, all expenses are deductible if they are laid out or expended wholly and exclusively for the purpose of the business, provided they

are not of a capital nature or in the nature of personal expenses. There are no territorial limits to this rule (except the restriction on deduction

of general administrative expenses of a foreign head office-see "Intercompany charges" below). Payments to affiliates in excess of

normal commercial rates may no be deducted.

Not with standing the general rule above, the Income Tax Act sets specific limits for the deductibility of certain specified expenses.

Capital expenditures are generally deductible only through depreciation or as the basis of property in determining capital gains or

losses.

TAXATION OF FOREIGN CORPORATION

IMPORTS

Imports without agent

Imports without representation in India (in the form of an agent, employee or salesperson, branch sales subsidiary, etc.) do not

normally subject the foreign exporter to Indian income tax if the sale is concluded in India, a part of the profits attributable to the sale is

subject to Indian tax. If the sale proceeds are received in India, the profit embedded in the receipts liable to Indian tax. However, treaties

restrict tax to profits attributable to a permanent establishment.

Unrelated agent, sole agent, employee / salesperson, branch

If the foreign company has an agent in India, the part of the profit attributable to the activities of the agent is liable to tax if a business connection is established. "Business connection" is an involved legal

concept that postulates business activities in India through or in connection with which the nonresident earns profits, and each case is

determined on its fact. Agents or salespersons with authority to conclude contracts will amount to a business connection. However, an unrelated Indian canvasser who cannot bind the principal may no lead

to a tax exposure if the terms are carefully stipulated. Employees, sales persons and branches are extensions of the foreign company and

are subject to tax on profits attributable to their activities.

Sales subsidiary

A subsidiary is not per se an agent or permanent establishment; and if it purchases at arm's length from its foreign parent company for resale

in India, the tax implications to the foreign company be the same as outlined above under "Import without agent." However, a subsidiary may, if its activities result in a business connection or if the a treaty

situation it is a dependent agent or a permanent establishment, expose the foreign company to tax.

Branch operations

Under treaties, a branch of a foreign company is a permanent establishment and the profits attributable to the branch are subject to

tax determined as if the branch were an independent enterprise engaged in the same or similar activities under the same or similar

conditions. Branches of foreign companies of nontreaty countries are taxed on income that is received in India or that arises or is deemed to

arise in India. If both the manufacture and sale are in India, the entire profits is taxed in India. When goods manufactured abroad are sold in

India, only the pat of the profit attributable to the selling activity is taxed in India, unless in a nontreaty situation the sale proceeds are

received in India. However, no income is deemed to accrue or arise in India from operations confined to the purchase of goods in India for the purpose of export. For computing taxable income, the rules relating to deductibility of expenses are the same as those applying to resident

companies. There is a limit on deduction of the general administrative expenses of the foreign head office, as indicated under "Intercompany

charges". However, this is overridden by some (but not all) treaties.

Except in special cases, a foreign company may general have a liaison office or a project office. The taxable income of such a project office may be determined on the same basis as above unless it does not

constitute a permanent establishment under a treaty.

In certain cases, taxable profits are determined at a specified percentage of receipts unless treaty provisions override.

Transfer of branch profits

A branch of a foreign company is liable to corporate tax at the rate applicable to a foreign company and is not liable to any additional

branch tax or withholding tax upon remittance of profits to the head office.

INCOME FROM SUBSIDIARIES

Dividends

Tax is withheld at 20 percent or a lower treaty rate (see Appendix IV) from dividends paid to foreign companies.

Interest

Certain interest is exempt from tax. Tax is withheld at 20 percent from other interest paid to foreign companies if the borrowing or debts incurred are in foreign currency. A lower treaty rate may prevail.

Royalties and fees for technical services.

Tax is withheld from royalties and fees for technical services paid to foreign companies by Indian concerns (under post-March 31, 1976

agreements that are either approved by Indian government or in accordance with declared industrial policy) at 30 percent on the gross

amount or a lower treaty rate (see Appendix IV). Some treaties exempt fees for technical services rendered abroad or specifically provide for

deduction of expenses.

Capital gains

Gains on transfer of assets situated in India (including shares in Indian companies) are subject to tax in India at 55 percent in the case of short term capital gains and at 20 percent in the case of long-term

capital gains.

Management fees

Management fees are rate and generally not permitted except in special cases. They normally stand on the same footing as fees for

technical services.

Rentals

Rental of equipment is treated on the same basis as royalties in many treaties. Otherwise, tax may be withheld from rentals at 55 percent of the net income. Ten percent of the rental earned by nonresidents from supplying plant and machinery on hire that is used or to be used in the prospecting for or extraction or production of mineral oil is treated as

taxable profit and subject to withholding tax at 55 percent.

Portfolio investments

Dividends, interest, royalties, and capital gains earned as portfolio income are treated in the same manner as income received from Indian subsidiaries. A reduced treaty rate is often prescribed for dividends where the foreign company hold more than a specified percentage of shares in the Indian company (see Appendix IV).

Concessional tax rates apply for foreign institutional investors. The provisions for computation of capital gains in foreign currency and

indexation of capital gains as applicable to other taxable entities are not applicable in the case of foreign institutional investors.

International financial center

It is not common for nonresident corporation to locate center in India to conduct a headquarters-type operation on a worldwide basis.

Although not prohibited, it may be difficult due to exchange controls. No special tax concessional are available.

TAXATION OF TRUSTS AND ESTATES


· Trusts are often used in family tax planning.

· Changes in tax laws have made trusts less attractive for commercial enterprises.

· Discretionary trusts maybe taxed at the maximum marginal rates applicable to individuals.

Trusts

India follows the English concept of a trust as a vehicle under which property is alienated from the original owners and held by a trustee for

the benefit of others. The law governing trusts is codified and contained in the Indian Trust Act.

Types of trusts

Common types of trusts are noted below.

· Public charitable or religious trusts

Income from these trusts is applied to charitable or religious purposes.

· Private trusts

Income from private trusts is available to specified beneficiaries and not the public at large. In some cases, the shares of the individual

beneficiaries are fixed or ascertainable, according to the provisions of the trust deed. In others (discretionary trusts), the trustee has the

power to apply the income among a class or group of beneficiaries in proportions determined entirely at the trustee's discretion.

Trusts are often used as vehicles to hold property for present or future needs of dependents and family members, and sometimes they are used to reduce the burden of tax. A common example is a trust that

provides for the accumulation of income and capital for specified infant children. Subject to their maintenance during this period, the

accumulation must be handed over to them upon their attaining a specified age or, in the case of a female beneficiary, upon marriage.

Retirement trusts are commonly set up be employers to provide retirement benefits to employees.

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Taxation of trusts

Subject to the fulfillment of specified conditions, a public trust is exempt from tax if the income is applied for charitable or religious

purposes. Approved retirement trusts are also exempt from tax. In the case of private trusts, if the individual shares of the beneficiaries are

ascertainable, they are included in the individual taxable incomes, the tax assessment being made either directly on the beneficiary or on the trustee as a representative of the beneficiary. However, if the trust has income from business, the entire income from the trust is taxed in the

hands of the trustee at the maximum marginal rate applicable to individuals unless the trust is created by will for the benefit of relatives. When the individual shares of the beneficiaries are

indeterminate (i.e., discretionary trust), the entire income is taxed din the hands of the trustees, in most cases at the maximum marginal rate

applicable to individuals.

Taxation of beneficiaries

Where tax on a discretionary trust is assessed in the hands of the trustee, after-tax distributions to the beneficiaries are exempt from tax

in their individual hands.

Tax treatment of settlor / grantor

If the trust effectively alienates income from the settlor/grantor, income tax liability thereon will be avoided. However, the

settlor/grantor continues to be liable to income tax on income from the settled property to the extent that it is for the immediate or deferred

benefit of a spouse or minor child. The transfer of assets to the trustee

maybe subject to gift tax. Stamp duty is payable on the transfer of immovable property.

Use of trusts

Trusts have been widely used as a planning tool to shift income to beneficiaries in lower tax brackets. Public charitable trusts are also

common vehicles. Recent changes in tax laws have made trusts less attractive for commercial enterprises

Estates

An estate continues to be subject to tax as a separate entity at the rates applicable to individuals until the property is distributed among

the heirs.

Tax System in India

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