How the FM can help business

How the FM can help business
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First Published: Wed, Feb 27 2008. 12 40 AM IST

(Imagery: Malay Karmakar/Mint)
(Imagery: Malay Karmakar/Mint)
Updated: Wed, Feb 27 2008. 12 40 AM IST
As finance minister P. Chidambaram prepares to present his Budget for 2008 to the nation, he may well be reminded of what Charles Dickens once wrote: “It was the best of times, it was the worst of times.”
(Imagery: Malay Karmakar/Mint)
That this is the best of times is obvious, thanks to reasonable robust economic growth this year and a declining fiscal deficit—it’s likely to be around 2.6% of the gross domestic product (GDP) for 2007-08, lower than the estimated 3.3%. The revenue deficit is expected to be 0.9% of GDP against the estimated 1.5%. Indeed, if this momentum continues, the target of achieving a zero revenue deficit by 2009, one of the objectives of the Fiscal Responsibility and Budget Management Act, 2003 (FRBM), may well be achieved.
Yet, this can be the worst of times in terms of challenges such as the volatility in the stock market, the worries over inflation, the continuing reluctance to raise oil prices adequately, stagnant agricultural growth and global recessionary trends, all of which can easily derail India’s growth story in the immediate future.
How can Chidambaram address both the opportunities and the challenges in this Budget?
There would be a strong positive impact on Indian companies and the capital markets, if the finance minster finally fulfils the promise of removing obnoxious surcharges on corporate tax— these were intended to be temporary, but have practically become part of the base rate. For example, deletion of the 10% surcharge will result in the tax rate declining from around 34% to 31%. This will make the Indian corporate tax rate more competitive in view of the KPMG corporate and indirect tax rate survey 2007, which revealed that the average global corporate tax rates are on a decline?(China,?for instance,?reduced it from 33% to 25% recently).
Another path-breaking measure would be to exempt dividend income received by Indian multinationals on their investments in overseas subsidiaries to the extent that they, in turn, declare dividends for their shareholders. This will encourage them to bring back profits earned by overseas subsidiaries and will make outbound acquisition opportunities more attractive.
Currently, venture capital funds (VCFs) are exempt from tax on income from investments, but only in firms in a list of eight sectors. This avoids double taxation, since tax is levied only at one level—in the hands of the unit holder in the VCFs—a bold proposal would be to extend the exemption to all sectors (except a small negative list where policy imperatives so dictate). Such a situation exists in the US, arguably the cradle of venture capital financing.
Till around two years ago, interest and dividend income, and capital gains from investments in infrastructure companies were exempt in the hands of investors. This was removed on the plea that interest rates were falling and there was no need to subsidize infrastructure projects. Interest rates have since risen a fair bit. The case for restoring the exemption to encourage private funding of infrastructure is clear.
Indian companies have for long been requesting to be allowed to carry forward tax losses in cases of change of control in unlisted companies, except where there’s evidence of tax avoidance as a motive for the change of control. In a challenging economic environment, promoters in unlisted companies may find both opportunity as well as succour in hiving off their control in unlisted companies, and it would be ironical to bring down the value of their investment because of non-availability of carryforward tax losses in their firms. This, then, is an opportunity to encourage genuine restructuring and diversification of Indian businesses.
The bane of Indian companies today is not that tax authorities tend to disagree with tax returns, but that the mechanism for ironing out disagreements in appeals is time-consuming, costly and fraught with uncertainties. A bold measure would be an alternative dispute mechanism to arrive at negotiated settlement with the taxpayer on contentious issues, leaving only a few strategic issues for further litigation.
It has unfortunately become an almost unfailing practice for the tax authorities to initiate penalty proceedings when a tax officer makes disallowances in respect of the taxpayer’s income. Penalty proceedings are then usually kept in abeyance till the merit disputes are settled in further appeal. This further makes foreign companies doing business in India extremely nervous about the legality of their stand on such tax issues. The international best practice is of initiating penalty proceedings only in those cases where there is a clear evidence of mala fide concealment of income. In most countries, where the taxpayer has fully disclosed facts and the tax officer makes adjustments to income returns while auditing, there’s no automatic initiation of penalty proceedings. If the finance minister addresses this issue satisfactorily, he will send a strong signal further demonstrating his commitment to making tax administration fairer.
Of late, there has been a significant increase in transfer pricing disputes. One approach that can minimize disputes is for the tax authorities to arrive at an agreement with foreign firms doing business in India by introducing an advance pricing mechanism (as prevalent in many countries). For example, the ongoing dispute and uncertainty around captive business process outsourcing firms—the transfer pricing authorities are attributing them to unrealistically?high cost-plus margins—could be mitigated by an upfront discussion with the advance pricing authorities with the help of actual data and economic analysis. This will mean less uncertainty for these captives.
Sudhir Kapadia is head, tax and regulatory services, KPMG. Comments are welcome at theirview@livemint.com
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First Published: Wed, Feb 27 2008. 12 40 AM IST