After the initial euphoria about the government’s supposedly simple draft direct tax code (DTC)—announced in August last year—died down, there was concern on many of the proposed draconian provisions such as a gross assets tax. Having been hardened by this experience, Budget 2010-11 is a piece of cake as far as the corporate tax proposals go.
However, I believe that this is really a lull before the storm, since the finance minister has clearly stated that the code will be introduced with effect from 1 April 1 2011, and therefore, this Budget may have passed off peacefully only because there would be no merit in making major changes to a law that will die in a year. The aspect that should really now come back into focus is how much the government has really taken on board the concerns that several quarters had raised on the DTC, and how and when the new law would be phased in.
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Nevertheless, several proposals have far-reaching consequences. For once, consistent lobbying has paid off and the error in the calculation of the tax holiday for units in tax-free special economic zones (SEZ) has now been corrected retroactively. However, what tempers this is the absence of any announcement on the government’s overall policy on tax holidays for SEZ units, and whether these incentives will continue under the DTC still remains a question. Similarly, there was no mention on whether the tax holidays for units in software technology parks will be extended.
Staying with tax holidays, a big boost has been given to the hospitality industry. Hotels with 2-star and above ratings set up anywhere in India that start operations after 1 April 2010 will now enjoy an investment-linked deduction. Hotels will be allowed to claim a 100% deduction of capital investments, other than on land and goodwill, in the year the investment is made. This would provide the hotels with accelerated deductions, and hence, defer tax liabilities. In cases of continued investments, the benefits will be greater.
Continuing the boost for research and development (R&D) initiatives, the weighted deduction for expenses on in-house R&D has been increased to 200% from the present 150%. This is a huge incentive for firms to increase spending. Increased deductions have been allowed on R&D contributions to specified institutions and universities.
Although the surcharge for companies has been reduced to 7.5% from the existing 10%, the dampener for corporate India is the increase in the rate of minimum alternate tax (MAT) from 15% to 18%. To my mind, there is no economic justification to increase the rate of MAT, particularly with the uncertainly surrounding the ability of companies to carry forward MAT credits under the DTC. The levy of MAT also marginalizes several tax incentives, including those available to the information technology sector under the software technology parks of India regime, and yet again, the government has used the MAT stick rather unfairly.
In a major change proposed that could significantly impact corporate reorganization, transfer of shares of an unlisted company to a partnership firm or a company for inadequate or no consideration would create a tax liability for the buyer on the difference between the fair value of the shares and the actual consideration. This would also apply in specific situations where seller is, otherwise, exempt from capital gains tax. This would hamper internal reorganization between family members and also create several absurdities, such as in case of a transfer between a holding company and its wholly owned subsidiary.
On the positive side, the conversion of a company to a limited liability partnership will not be liable to capital gains. This may, unfortunately, have a limited impact since it would only apply if the company’s turnover is less than Rs60 lakh.
Continuing with the trend of amendments to overturn the impact of court rulings, the law is to be amended to clarify that non-residents will be liable to tax in India on fees for technical services received even if the services are performed outside India. This would bring several foreign companies into the tax net and increase costs for Indian companies.
There have been other minor amendments in some provisions, including a change that allows high courts to condone delays in filing of appeals—a reward for inefficiency! Missing from the Budget are several changes that should have been made to improve tax administration and collection.
I have always advocated that stability in the tax regime is welcome, and whatever be the reasons, the changes this time are marginal. While industry always has a long list of expectations and most of them would be disappointed on that measure, I believe that the game has changed.
Profit-linked incentives and sectoral exemptions are now passé and the focus of the government has changed to attacking several tax-planning tools by introducing anti-abuse provisions. The rules of the game will now demand higher sophistication from taxpayers as well as administrators.
These are the author’s personal views. Respond to this column at firstname.lastname@example.org