An emphasis on plugging gaps

An emphasis on plugging gaps

Considering the multiple challenges the economy faces, finance minister Pranab Mukherjee has presented a budget that addresses the common man’s plea for respite from soaring prices and balances it with continuation of reforms process.

What is more encouraging is the emphasis on plugging implementation gaps, leakages from public programmes and the quality of outcomes—a step forward in the transition towards a more transparent and result-oriented economic management.

However, one can’t help but have a niggling thought about the optimism shown by Mukherjee about the revenue and expenditure numbers. Having brought down the fiscal deficit from 5.5% to 5.1% of gross domestic product (GDP) for 2010-11, the target for 2011-12 has been kept at 4.6%.

At the same time, Central government debt as a proportion of GDP is estimated at 44.2% for 2011-12 as against 52.5% recommended by the 13th Finance Commission. These calculations are no doubt backed by the confidence in the implementation of the twin tax reforms of the direct taxes code (DTC) and the goods and services tax (GST).

The reaffirmation by the finance minister about the implementation of DTC from 2012 has signalled that tax policy is gaining stability. In keeping with the thinking of phasing out surcharge under DTC, the lowering of surcharge on domestic firms from 7.5% to 5% is a welcome step, even with the base minimum alternate tax (MAT) rate being hiked from 18% to 18.5%. The marginal relief provided to individual taxpayers by enhancing the exemption limit from the existing 1.6 lakh to 1.8 lakh is a positive move that would put some extra funds in the common man’s pocket. Again, it is a step towards transitioning to the exemption limit of 2 lakh envisioned in DTC.

Although infrastructure bagged goodies by way of increased allocation and funding, which would be possible through the issue of infrastructure debt securities, it lost significantly on its expectations on the LLP front. After the Limited Liability Partnership Bill was passed, this industry had high hopes on implementing LLP for carrying out projects.

The tax-partnership status granted in Finance Act, 2009, was another driving reason for formation of LLPs in the infrastructure sector as it could help minimize the leakage on dividend distribution tax (DDT) and minimum alternate tax (MAT) fronts, which otherwise happens due to the special purpose vehicle-based model.

However, the budget has introduced MAT on LLPs, which will restore the inefficiencies which existed earlier. Infrastructure projects that are otherwise eligible for incentives shall be taxable under MAT at the rate of 20% on such incomes. An interesting change from the current MAT framework for firms is a different way of computing income for MAT, specifically with regard to long-term capital gains exempted for listed stocks.

On indirect taxes front, the overall theme of structural changes is to broaden the tax base. The conscious decision to maintain peak excise duty rate at the current levels is laudable. Not only would it help tackle the current inflationary pressures, it would be in sync with the rates envisaged in the GST regime.

The other important announcement is change in time of application of service tax from payment of cash to accrual of amount due and to commence a review of converting the positive list of taxable services into a negative list of exempt services. Though the finance minister has reiterated his promise to further liberalize the foreign direct investment policy, the industry did expect him to announce key policy changes in sectors such as insurance or multi-brand retail. However, other measures have been announced to attract foreign investment.

Direct investment in mutual funds by any foreign investor who meets the specified norms is a path-breaking measure that would allow the funds to have direct access to foreign investors and widen the class of foreign investors in the equity market. It could also address concerns about declining FDI in recent times.

Increasing foreign institutional investor limit on corporate bonds of infrastructure companies to $40 billion, as well as reducing the withholding tax on interest payment on the borrowing of foreign funds from 20% to 5%, would go a long way in enabling infrastructure financing at globally competitive rates.

Further, the reduction of tax to 15% on foreign dividends received by companies from foreign subsidiary is welcome. Creation of special vehicles in the form of notified infrastructure debt funds, with tax exemption to the fund, would LET foreign funds flow for financing of infrastructure.

Given the uncertain global economic conditions, one hopes the initiatives would help yield positive inflows to India.

He is country managing partner, E&Y