– By Anuj Agarwal and Prabhanu Sikaria
As India steps into yet another promising year of growth, all eyes are on the Budget primed to steer the economy forward. While the six-pronged bottoms-up approach is laudable for Amrit Kaal and Viksit India @2047, it is equally important to address topical headwinds and look at reforms from a short-to-medium term perspective. Increasing domestic consumption, boosting investments and finance in the country, stagnation in global economic growth and the resultant lower demand for India’s manufacturing exports, inclusion of MSMEs, are some key focus areas for policy making and budgetary support.
In the same vein, tax measures can nudge domestic industries to buckle-up to the imminent challenges that lie ahead.
First, tax reforms in the manufacturing sector are an absolute need of the hour. The sector contributes about 15 percent of the country’s GDP of FY 24, down a couple percentage points from a decade back. December 2024’s manufacturing PMI was subdued, the weakest in last 12 months, amidst soft signs of slow growth in the sector. A lower income tax rate for select manufacturing class critical for growth, will be much welcome. Production linked incentives (PLI), a flagship government scheme, have fared well in garnering about US$15 billion; broad basing the PLI to other sectors such as electronic components, steel, can significantly boost India’s quest of raising the manufacturing share of the GDP. Also, employment-linked incentives such as additional weighted deductions, can be factored to boost employment generation in the sector.
The services sector, on the other hand, has recorded an upward trajectory. Global Capability Centers (GCCs) particularly, have been instrumental in augmenting growth. India has emerged as a global hub and a ‘destination of choice’ for GCCs, driven by the country’s vast skilled talent pool. As of March 2024, the number of GCCs established in India has grown to 1,700, generating US$ 64.6 billion in export revenues and employing over 1.9 million people. To further cultivate the GCC ecosystem, the current safe harbor margins can be rationalized to align with industry and global trends. For instance, margins for ITeS and KPO services may be revised downwards to a range of 12-14 percent. Wider acceptance of safe harbour margins by taxpayers can help to reduce tax disputes and yield upfront tax certainty. Like for the manufacturing sector, employment incentives can be considered for accretive service businesses too. All these measures could solidify the country’s position as a global leader and create substantial employment opportunities.
On the administrative front, last year’s Budget saw an announcement for a comprehensive review of the extant income tax law primarily aimed at reducing disputes, fostering greater tax certainty, and eliminating redundant provisions. Initial steps were taken in last year’s Budget by simplifying the tax regime for charities, streamlining the withholding tax rate structure, revising provisions for reassessment and search operations, and rationalizing the capital gains taxation. Building on this momentum, it will auger well if the Budget could prioritize simplifying certain onerous compliance obligations. For instance, there is scope to further simplify the withholding tax framework by having only, let’s say, 2 to 3 broad rate categories, with either uniform transaction value-based thresholds or the removal of thresholds altogether. Clarifications can also be issued on some of the litigious tax issues such as applicability of the recently introduced protocol to the India-Mauritius tax treaty, taxability of contingent consideration in M&A deals, to help check potentially budding tax litigations for future.
Next, with respect to the global tax landscape, clarity is needed on India’s stance and roadmap for implementation of OECDs Pillar 2 project. India is a member of the OECD / G20 Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) Pillar 2 project. The IF was tasked to implement the GloBE Rules, which mandate multinational enterprises to pay a minimum level of tax in each jurisdiction it operates. A clear policy implementation roadmap will allow taxpayers sufficient time to brace themselves for the rules.
Lastly, India has steps to take to further incentivise sustainability in business practices and living at large. India has committed to achieving a net-zero carbon emissions goal by 2070 and reduce its carbon intensity by 45 percent by 2030, as per its commitments under the Paris Agreement. Tax incentives could play a pivotal role in mobilizing foreign capital for green projects, enhancing their attractiveness by offering higher yields to investors while at the same time optimising the cost of raising finance for borrowers in India. Many countries, including Brazil, the USA, and Malaysia, have already implemented similar tax measures to strengthen their local green bond markets. Some tax proposals could include tax exemptions / relief for income from green bond investments.
Green hydrogen as an alternate source of energy, carries potential to reduce carbon emissions particularly in the power and transport industries, presenting a compelling case for a fiscal boost. From an indirect tax standpoint, upfront exemption from the basic customs duty of 40 percent on import of solar modules with specified end-use condition of exclusive use for solar power plants supplying electricity to green hydrogen projects, can help the sector. Further, the benefit of the project import scheme with a concessional basic customs duty of 7.5 percent on ‘solar power plants or solar power projects set up for the supply of electricity exclusively to a green hydrogen project’ should be considered. Last, adoption of electric vehicles (EVs) in the overall vehicle sales segment will be key to accelerate transport electrification. In this respect, the budget should clarify perquisite taxation rules and extend the period for deduction of interest on loans availed for purchase of EVs.
It is noteworthy to see the tax-to-GDP ratio on the rise, to about 12 percent, as per budgetary estimates for FY 25, from around 10 percent in FY 15. Given the recent buoyancy in tax collections and improved voluntary taxpayer compliances, significant tax revenues can be offered to finance developmental goals. Finally, as India strides towards becoming a US$ 5 trillion economy, a competitive and predictable tax framework will be a cornerstone for sustained growth.
(Anuj Agarwal is Partner at Deloitte India; and Prabhanu Sikaria is Associate Director at Deloitte India.)
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