The overall direction of reforms will remain unchanged

The overall direction of reforms will remain unchanged

With less than a week remaining for the annual mega economic event, all eyes are focused on India’s most experienced finance minister, who has a challenge of sorts to meet competing objectives of growth, a fiscal deficit, reforms, and above all, controlling inflation and burgeoning subsidies. The outcome of state assembly elections last week has lead businesses to believe a further slowdown in reforms. Though I don’t entirely share the sentiments barring reforms such as foreign direct investment (FDI) in retail and increasing FDI limit on insurance, I think that the overall direction of reforms will remain unchanged.

Digging deeper into taxpayers’ pockets

Given that the current service tax collection comprises less than 6% of GDP and with a nearly 60% weight of the services sector in the GDP basket, this is an economically feasible move in the budget. The differences with states on how certain elements of telecommunications, insurance and banking services considered to be of national importance have to be taxed will continue. This, however, does not preclude the Centre from going ahead with the reform, given that it’s a logical graduation to a GST regime in addition to addressing ongoing litigation in relation to classification issues. In addition, taxing all services would ensure that most forms of health, education and public transportation come within the tax net and yield substantial tax revenue.

GST still a distant dream

Pranab Mukherjee. Photo by Bloomberg

Plan panel times its recommendations

On the direct tax front, changing of slab rates for individuals, besides additional relief on savings instruments to combat the impact of double-digit inflation, will be on top of the agenda. However, major recommendations of the Plan panel on the direct taxes code (DTC) with respect to individuals would be deferred to 2013 and made to coincide with the new DTC law. On anticipated lines, we may witness a spate of regulations to deal with tax avoidance in the form of general anti-avoidance rules (GAAR), controlled foreign corporation (CFC) rules and a strict test for determination of place of effective management (POEM) for foreign companies. The desire to have some form of GAAR would be a natural outcome of the impeding DTC and the need to accelerate the Supreme Court’s directive in the Vodafone case, which emphasized on a need for regulations to deal with tax avoidance. The CFC mechanism for accelerated taxation of undistributed profits, hitherto not taxed, of foreign subsidiaries owned and controlled by Indian residents was signalled in the 2011 budget by allowing a one-year window to tax dividends (remitted to India) at a fixed rate of 15%. POEM would entail a strict residence test for foreign companies and the consequential taxability of Indian sourced income by applying attribution rules to profits otherwise taxed overseas.

All of this would mean incremental tax revenue, and hence I see these measures featuring in the budget. Although all such measures are fashionable for India to replicate, the fear is their administration. Businesses fear ad hoc and subjective use of such anti-avoidance measures and a lack of adequate safeguards. Though the second DTC draft has made an attempt to assuage such sentiments, the standing committee on DTC has made some valuable suggestions that merit consideration. The onus to prove that tax avoidance is on the administration and not the taxpayer, treaty provisions not to be overridden by domestic law are all aligned to international principles and worthy of consideration. A rushed legislation would merely harm business sentiment besides inviting litigation.

Addressing transfer pricing disputes

Though the advance pricing agreement (APA) to lend certainty to transfer pricing on cross-border transactions was meant to be on the DTC agenda, it seems the government is keen on accelerating this important reform. The government committee on APA has made substantial progress, and views have been sought from several foreign jurisdictions and the Organisation for Economic Co-operation and Development (OECD) for embracing best practices, indicating its resolve to implement a bilateral APA regime. This will ensure that taxpayers have certainty in India and foreign jurisdictions. Again, the Plan panel has made recommendations for independence of the APA authority and the need to spare small businesses with minimalistic value of international transactions being spared from onerous compliance obligations.

A rushed voluntary disclosure of income scheme or strategic approach?

Given the populist sentiment on checking illicit income in foreign banks, we could well see a spate of administrative measures that would entail enhanced disclosures of foreign bank accounts, widening of the wealth tax base for taking offshore assets, etc. The time limit to reopen past tax cases from the current six-year limit to 10 years is also aimed in the same direction. I don’t see the big bang voluntary disclosure scheme announcement as the so-called black money panel has been granted an extension until 31 March to submit its findings. The panel comprised of officials from the Central Board of Direct Taxes, the Directorate of Revenue Intelligence, the Enforcement Directorate, the Financial intelligence Unit and the law ministry is yet to reconcile its views. In addition, the government has to deal with the apex court’s directive to set up a special investigation team headed by a retired Supreme Court judge, for which a review is sought. Simultaneously, India continues to champion the global transparency forum and play a pivotal role in accelerating signing of tax information agreements with treaty and non-treaty partners. The progress in this direction is gradual and my assessment is that the finance ministry has a medium- to long-term strategy in mind. Hence, this cannot be viewed as a budget-alone reform.

In conclusion, lots in store for the week. I will anxiously wait and witness Indian media’s flagship event.

Mukesh Butani is chairman and managing partner, BMR Advisors