India: Potential tax and financial consequences of covid-19

​published on 30 March 2020 | reading time approx. 2 minutes

Rapid spread of covid-19 with increasing number of confirmed cases and deaths is causing deep concern around the world. Strict measures are being announced by the Government across the globe to contain the spread of this virus. Amidst uncertainty, business leaders and decision makers strive hard to ensure safety of their employees and work on the business continuity plan.

• Restrictive movement of employees

• Arm’s Length Price and Margin Requirements

• Export benefits under Goods and Service Tax and Foreign Trade Policy

• Management of cash flow of the Indian subsidiary

• Relief measures on account of lockdown

 
While responding to this challenging situation, one may come across various tax and financial issues that require timely consideration and planning to avoid any adverse consequences in future. Below we have highlighted few such aspects :

 
Restrictive movement of employees

Countries across the world have put strict restrictions on mobility of people. Inter-alia, India has temporarily suspended visas and has put in stringent guidelines in relation to people mobility. It is important to understand the local visa regulations to ensure safety of  one’s people. Depending on the extent of the contagion, these restrictions may continue for several months. Such restrictions may lead to the following tax consequences :

1.  Permanent Establishment (PE) : Presence of employees of a foreign entity in India beyond a specified threshold period, for assembly, construction or supervision thereof, may trigger a PE of a foreign entity in India. Usually, the Indian tax officers tend to include temporary interruptions while calculating number of days for determining the PE. Projects which have been kept on halt due to covid-19 may trigger PE exposure.
2. PE exposure of Indian company in other jurisdiction : Restrictions and option of carrying out board meeting via video conferencing – this may expose the Indian subsidiary creating a PE in the foreign country (such as Germany) due to management activities (key management and commercial decisions) being performed in such foreign country. Above issues are just indicative of how mobility restrictions due to covid-19 situation is likely to disrupt the tax planning. It is thus important to identify the risk and have mitigation plan in place.

  
Arm’s Length Price and Margin Requirements

Covid-19 is likely to have substantial impact on the profitability situation of companies. Indian subsidiaries with routine functions are expected to maintain a minimum profit margin. Losses if any earned by such routine enterprise generated due to capacity utilisation and / or slack in market demand due to the covid-19 situation should ideally be borne by the principal which performs key functions and bears major economic risks. It will be important to identify the losses caused due to this situation and to prepare corresponding documentations to explain which party should bear the losses.

 
On the other hand, any change in the method of valuation of goods imported by the Indian subsidiaries to cater to the loss situation will have an impact from a customs valuation standpoint (Special Valuation Branch or ‘SVB’ procedure). Such situations require analysis both from transfer pricing and customs perspective.

Export benefits under Goods and Service Tax and Foreign Trade Policy

Covid-19 is also expected to impact the cash flow situation of the businesses. There may be a situation where an exporter is not able to realise export proceeds within the time frame specified by the Reserve Bank of India. Apart from the foreign exchange control contravention, this may also have an impact on the export incentives entitled to the company under the Foreign Trade Policy as well as refunds provided under the Goods and Service Tax Law. It would be pertinent to monitor the realisation of export proceeds and take appropriate action to avoid any adverse tax consequences.

Management of cash flow of the Indian subsidiary

If this crisis continues for a longer period, this may call for discussion around infusion of funds to support the Indian operation. Given the situation, not many companies would be willing to use their own funds and would in-turn like to borrow from local banks to cater to this additional / extraordinary funding requirement. This has its own set of challenge such as:

1.  Restriction on interest payments : Indian foreign exchange control law restricts the rate of interest that can be charged on foreign borrowings. This may lead to peculiar situations, for instance, lending company (assuming, in Germany) ends up paying higher interest to the local banks than it can recover from the Indian borrowing entity.  
2. Interest deduction limitation (thin capitalization) : Indian domestic tax law restricts deductibility of interest. Interest payment to non-resident associated enterprise (including cases where associated enterprise provides guarantee) equivalent to 30 percent of EBIDTA. The excess interest, if any, can be carried forward and set off for 8 years.
   Selection of optimum mode of funding in this difficult time would inter-alia depend upon the business requirements, availability of funds, tax and regulatory implications, etc.

Relief measures on account of lockdown

Subsequent to nation-wide lockdown, Indian Government on March 24, 2020 has announced several relief measures which inter-alia includes extension of due date to file belated income-tax return and Goods and Service Tax monthly returns for March, April and May to June 30, 2020; reduction in interest rate for late deposit of withholding tax from 18 percent to 9 percent; etc. A separate news alert providing detail of such relief measures will follow.

 
Supreme Court of India has also extended limitation period applicable on general/special law with effect from March 15, 2020 till any further order in this regard. This will provide some respite to litigant who were facing difficulty in meeting the deadline to file petitions/applications/suits/appeals etc. to any court/ tribunal/other authorities in India due to lockdown.

 
We have highlighted above, instances of how covid-19 may have an impact on few of your India tax and financial planning. Please also refer to our alert on legal and regulatory challenges from India perspective arising out of this unique situation.

 
It is our endeavour to have you covered from tax and regulatory challenges that may arise from covid-19 situation. You may reach out to us to discuss impact of covid-19 situation on your business and mitigation strategy.