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Need of the hour: direct tax stimulus measures

Need of the hour: direct tax stimulus measures
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First Published: Mon, May 04 2009. 06 39 AM IST

Updated: Mon, May 04 2009. 09 49 AM IST
The failure of large international banks, insurance companies and the subprime crisis in the US have resulted in one of the most vicious economic meltdowns the world has witnessed.
India, till a few years ago one of the world’s best-performing economies, has also not been insulated. The steep fall in realty prices and liquidity crunch that hit real estate companies hard, the sharp decline of the rupee against the dollar that left Indian companies wounded with substantial forex losses and falling consumer demand have all played a role in the current economic situation.
The recently released annual policy statement 2009-10 by the Reserve Bank of India begins thus: “This annual policy statement for 2009-10 is set in the context of exceptionally challenging circumstances in the global economy... The World Trade Organization has forecast that global trade volume will contract by 9% in 2009... Governments and central banks around the world have responded to the crisis through both conventional and unconventional fiscal and monetary measures.”
In such times, the government, through its fiscal and monetary policies, has an important role in stimulating the economy and increasing public confidence.
The new government will shortly assume power and one hopes the compelling need of the economy will be part of its list of priorities! In that context, this article seeks to suggest some direct tax stimulus measures that the government could consider introducing (at least for a defined period), which could provide a much-needed boost to Indian industry.
The authors are aware that the attempt of the last few years has been to reduce fiscal incentives and thereby prevent distortion. This is a commendable objective, but these are not normal times and one would submit that the responses need to be aligned to the reality.
Development of infrastructure such as roads, ports, airports, power facilities, etc., besides providing better amenities to people, is also an engine of substantial economic activity. The development of infrastructure facilities would lead to employment generation and create demand for industrial products such as steel, cement, etc. However, such projects have a long gestation period and hence require commitment of funds for a substantial period of time.
In the current economic environment, to attract funds for infrastructure projects, the government could consider providing certain direct tax benefits to those investing in such projects.
Recognizing the importance of providing tax benefits to infrastructure project investors, the government in 1996 had introduced section 10 (23G) in the Income-tax (I-T) Act, 1961. This section exempted income in the nature of dividend (other than exempt dividend), interest and long-term capital gains derived by certain investors in specified infrastructure projects. The objective of the section was to primarily incentivize lending to infrastructure projects, to reduce the cost of debt, and improve economic viability.
However, the removal of section 10 (23G) has made it harder for such infrastructure projects to establish credit support from lenders.
Considering the need for infrastructure in the country, the need for private sector participation and the risk that is taken for financing such long-term assets, fiscal support to encourage lenders to invest in such projects is essential. Therefore, to give the much-needed boost to the infrastructure sector, section 10 (23G) could be reinstated.
Investment allowance
In this slowdown, investments in new projects and expansion of capacities have dropped considerably. This has also affected the growth of the economy and acted as a deterrent to employment generation. Therefore, to boost economic activity and enhance employment generation, the government could consider reintroducing an “investment allowance” to fuel growth and attract investment in new projects (erstwhile provisions relating to “investment allowance” broadly provided incentives such as deduction at 25% of the actual cost of investment in new plant and machinery).
In a recently concluded tax contribution survey conducted among Indian companies by Ficci and PricewaterhouseCoopers, it was found that Indian companies have a substantial tax burden of taxes. The burden is manifested by the average total tax rate, which is almost 36% of profit before all taxes (41% if one excludes the information technology sector). Later media reports indicate that Ficci has suggested the reintroduction of investment allowance, which could probably reduce the overall tax burden of Indian companies.
In view of fiscal deficit constraints, the investment allowance window could be for a limited period, say, for investments till 31 March 2010.
Housing and real estate
As mentioned earlier, real estate companies are facing a deep crisis, with erosion in prices coupled with a substantial fall in demand. As a result, a number of companies in this sector are facing a severe liquidity crunch. A potential issue in the sector could have a significant adverse snowballing effect and hence it seems worth considering some boost to the sector.
Typically, an individual avails of a housing loan to buy a property. Presently, section 24(b) of the I-T Act provides for a deduction of up to Rs1.5 lakh a year towards interest on borrowed capital for acquiring a self-occupied house property.
In the present time, an increase in the quantum of interest deduction to, say, Rs5 lakh could provide substantial stimulus to individuals to purchase property. This could potentially create demand for the housing sector.
Second, currently tax depreciation on commercial property is 10%. An increase in tax depreciation on commercial property to, say, 20% could also act as a stimulus to purchase commercial property and consequently give a stimulus to the real estate market.
Aviation industry
In the current economic environment, companies trying to cut costs have substantially cut or put an embargo on air travel. Thus, there has been a substantial decline in air travel. As a result, domestic air carriers have reported substantial losses.
The tax burden that airline companies need to bear on aircraft leased from foreign companies is a substantial tax cost. Earlier, section (15A) of the I-T Act provided for an exemption in respect of payments made by an Indian company engaged in the operation of aircraft to a foreign state or foreign enterprise for acquiring an aircraft or aircraft engine on lease under an agreement approved by the Union government. The Finance Act, 2006, discontinued the exemption. Restoration of this exemption could provide a relief to the aviation industry.
Summing up
While India is less badly hit, one should not underestimate the impact and it would be naive to overplay the decoupling argument. Clearly, if the damage is to be mitigated, India needs to act and act fast, and several measures have already been taken. Some additional measures such as those suggested above could be considered as add-ons and one hopes the new government will take note of these ideas.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at groundrules@livemint.com
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First Published: Mon, May 04 2009. 06 39 AM IST