The Union Budget was presented last Friday against the backdrop of the reality of elections next year. From a direct tax perspective, despite the elections looming, there was an expectation of tax cuts for the corporate sector and indeed, some sops for the infrastructure, exports and information technology (IT) and IT-enabled services (ITeS) sectors, especially given the significant buoyancy in corporate tax collections which now comprise almost 31% of direct tax collections. In fact, corporate tax collections have grown by 17% in the previous fiscal and are expected to grow at 23% this fiscal year.
Clearly, the Budget has been a story of unfulfilled expectations; in fact, unfortunately, a disturbing trend of retrospective amendments has reared its head, creating uncertainty and discomfort as to the sanctity of judicial pronouncements. This article seeks to address both issues.
There is no change in the corporate taxation rate. Industry expectation of either a reduction in basic corporate tax rate from 30% to 25% or a removal of the 10% surcharge to minimize the overall corporate tax burden was completely overlooked, in spite of the buoyant corporate tax collections trend over the past few years.
Illustration: Jayachandran/ Mint
Industry demands for abolition of, or reduction in, the minimum alternate tax (MAT) rate as well as dividend distribution tax (DDT) have also not been met. Thankfully, the cascading impact of DDT has been sought to be neutralized, in relation to dividends derived by a parent from its subsidiary.
There has been significant relief, however, to individual taxpayers, especially the lower income slabs, and those earning more than Rs5 lakh.
No infrastructure sops
A majority of infrastructure exemptions and deductions will reach the tax holiday sunset period within the next year or two.
Given that the Five-year Plan talks of the infrastructure investment needed, and especially given that the lack of infrastucture is one of the significant deterrents to the India growth story, one would have expected some sops for the infrastructure industry. In fact, there had been some indications on that front, such as exemptions for investments in infrastructure. Not only has that not happened, there have not been any sops for companies engaged in infrastructure. In fact, in relation to a deduction hitherto available to new units set up for refining mineral oils, a sunset clause has been added to provide that the undertaking will not get the deduction unless the refining goes on stream by 31 March 2009.
Two small deductions have been added, but these are severely ring-fenced (that is, subject to several conditions); one is a deduction for profits from operating and maintaining a hospital other than in specified urban areas, whereby 100% of the profits would be exempt for five years, and the second is in relation to establishing hotels in certain specified districts having a world heritage site, where again the deduction is 100% for five years.
The Budget has not extended the tax holiday period for companies engaged in scientific research and development activities. However, a ring-fenced relief has been provided in the form of a weighted deduction of 125% for contributions to an approved research and development company under section 35(1)(iia).
No relief on exports
The Budget has not provided any direct tax sops to the country’s fast-growing IT sector, which is facing a triple whammy in the form of an almost 13% appreciation of the rupee against the dollar in the last one year, a significant wage spiral and a slowdown in the US economy, which have all converged to significantly impact margins.
In this context, the sector was expecting a fresh lease of life from the Budget in the form of extension of the tax holiday for the Software Technology Parks of India scheme beyond 31 March 2009. This has not happened.
Clearly, many of the factors are also common to other exporting industries, including auto components and textiles, the latter having been particularly badly impacted. While the government has enunciated (pursuant to the Kelkar Committee Report) the laudable objective of not having too many exemptions, on the basis that they lead to distortion of the fiscal regime, the changing dynamics of the economic landscape could have been borne in mind. Perhaps an extension of the export-oriented unit (EOU) scheme could have been considered, especially given that the supply of real estate in special economic zones (SEZs) often prevents small and medium units from locating there. The fact of the exemption no longer being available to EOUs will put them at a further competitive disadvantage, especially vis-à-vis large units located in SEZs.
What else is missing?
Several corporate sector demands; here is an illustrative list of some key items:
Tax breaks on corporate restructuring: Several representations have been made over the last few years that corporate restructuring needs to be facilitated by removing certain irritants in direct taxes. One example is the definition of demerger, which is very restrictive; another is that the merger of loss-making companies into profit-making companies is hemmed in by several restrictive conditions which act as a deterrent to consolidation. Again, tendering of shares in an open offer, or buy-back, is leviable to capital gains tax, whereas it is not so if the shares are sold on the stock exchange. None of these irritants have been addressed at all.
Characterization of foreign institutional investor (FII) income: There is as yet no clarity on the characterization of FII income (business income vs. capital gains). One recognizes the sensitivity of this issue on the capital market; perhaps, one way of addressing this could be to outline a “road map”, at the end of which the status quo would change; also, stability could be built in, with some transitional measures, for the interregnum.
Real estate investment trusts (Reits): The Securities and Exchange Board of India has formulated draft regulations on Reits to encourage and facilitate their healthy growth in India. Reits can become an investment vehicle of choice for institutional and retail investors looking to participate in real estate ownership, management and development. The Budget has not laid out any tax regulations with respect to Reits—hence, Reits may not take off.
Advance pricing agreement (APA): APA, in brief, settles the transfer pricing methodology and the range of profit margins to be adopted by a taxpayer for an agreed number of years. It is aimed at providing multinationals a certainty as regards pricing of transactions with related entities. While one recognizes that it is extremely difficult to effectuate an APA mechanism, perhaps a policy announcement, at least outlining the intent, would have given some comfort.
The disturbing trend of several retrospective amendments has emerged, and three main amendments and implications are as follows:
Earlier, an assessee was considered as “assessee in default” if, after deducting taxes, he failed to pay the same to the exchequer. Section 201 has been amended to provide that even failure for non-deduction would now attract the provisions of the said section and the assessee will be considered as “assessee in default”; this is stated to be retrospective from 1 June 2002, and one is not sure as to the constitutional validity of this provision.
In the context of the claim of depreciation beyond a tax exemption period, judicial precedents supported the proposition that depreciation would not be deemed to be allowed, and the depreciation beyond the tax exemption period would be on the larger non-depreciation base. This has been retrospectively amended from 1 April 2003.
Deferred tax and DDT, if debited to the profit and loss account, was not (as per judicial precedents) to be added in arriving at “book profits” for MAT purposes. The said items are included, and retrospectively, from 1 April 2001.
The memorandum explaining the Budget provides that the aforesaid amendments are more of a clarificatory nature. However, the rationale for making the aforesaid amendments retrospectively applicable merits consideration. These amendments could lead to many closed assessments being reopened by the revenue authorities and, consequentially, long-drawn litigation could follow.
All in all, on the direct tax front, the Budget has not met several important corporate sector demands. One hopes that the direct tax code (originally intended as a simplification document) addresses some of these demands, especially those which do not have major revenue implications.
Ketan Dalal is executive director of PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org