Budget should provide a bigger impetus to financial services

The Union Budget 2017 is expected to have several distinctive features in comparison to earlier budgets:

It’s the first budget post demonetisation.

It’s scheduled to be introduced on 1 February instead of 28 February in past years.

It combines the railway budget.

It will be silent on plan and non-plan expenditure.

The government’s fiscal reforms to boost investor confidence have raised expectations from the budget, which range from fiscal incentives to administrative conveniences to higher allocations. Likewise are the expectations of the financial services industry which could be summarized as follows:

Incentives for digital push

Ever since the announcement of demonetisation, the government has enhanced its promotion of digital payments. While in the long-term the cost of digital transactions may be significantly lower than the cost of handling cash, in the short run, significant investment may be needed for capacity building and ensuring a safe digital environment.

So, any investment needed for a digital push should be compensated by way of reduced tax outgo either through accelerated depreciation/deduction of expenditure or compensating the losses suffered by banks/payment entities as a result of reduction in transactions costs to push/ incentivize cashless transactions.

Stressed assets

The Indian banking industry is still mired in high levels of non-performing assets (NPAs). While on the one hand, it eats into the capital of the banks, on the other, tax deduction for provision for NPAs is restricted to a certain percentage of taxable income as against the actual amount of NPA provision created in the books of account, resulting in a higher tax outflow. It is therefore required that:

(a) Full tax deduction for NPA provision created in the books of account should be allowed. Further, tax deduction for NPA provision is currently available only to banks and non-banking financial companies (NBFCs). Similarly, tax deduction should be extended even to HFCs.

(b) The government should allocate a higher kitty for recapitalization of banks, especially considering the applicability of the Basel III framework from March 2019.

(c) For quick resolution of stressed assets, adequate capacity should be built in terms of benches, judges and judicial staff of NCLT (National Company Law Tribunal) and DRT (Debt Recovery Tribunal) to take care of the anticipated volume of cases with the introduction of the Insolvency and Bankruptcy Code, 2016.

(d) As per Section 43D of the Income-tax Act, 1961 (Act) income on certain NPAs is taxable only in the year of receipt. Currently, the provisions of Section 43D are applicable only to banks and financial institutions. Under the prudential regulations, even NBFCs are required to recognize income on NPAs only on receipt basis; however, for tax purposes such entities are required to follow accrual basis. Given this, the provisions of Section 43D should be extended even to NBFCs.

Taxability of rupee denominated borrowings

Currently, Section 194LC of the Act provides for a concessional rate of tax of 5% in case of interest payable on monies borrowed in foreign currency (whether under a loan arrangement or by way of issue of long-term bonds) by an Indian company. Given the language of Section 194LC, doubts have arisen whether the concessional rate of 5% applies even in relation to borrowings from abroad but expressed in rupee terms. To allay these doubts, it should be clarified that the provisions of Section 194LC apply even in relation to rupee-denominated borrowings from abroad.

Trading in bonds listed abroad

Very often, the bonds issued by Indian companies are listed on securities exchanges outside India and are actively traded. While technically any transfer of such bonds between two non-residents is taxable in India and even obligates the acquirer to withhold tax as per the Indian tax laws, adherence to such requirements is seldom practicable.

Accordingly, any transfer of the bonds issued by Indian companies on a stock exchange outside India should be exempt from tax in India—any attempt to tax such transfers may restrain the ability of Indian companies to raise money outside India.

Conclusion

The aforesaid are merely illustrative of key matters that should be addressed by the finance minister in the Union budget 2017. In addition to this, clarity is also needed in relation to taxability of re-insurance companies, clarity on applicability of indirect transfer provisions to fund structures/portfolio investors in wake of the recent Central Board of Direct Taxes circular, which for the time being has been put on hold, etc.

As mentioned earlier, Union Budget 2017 is expected to have several distinctive features and one hopes it also achieves the distinctiveness of providing further impetus to the growing financial services industry.

Naresh Makhijani is partner and head of financial services at KPMG in India.

Views expressed are personal.