An open letter to finance minister Arun Jaitley on tax reforms
Dear Mr Jaitley,
It is that time of the year when you will, no doubt, be flooded with wish-lists and “sage advice” from all quarters. You would have realised by now that, despite your protestations to the contrary, a huge amount of expectations ride on your maiden full-year budget this week. Keeping these expectations in mind, I have attempted to summarise some of the critical tax issues which need your urgent and serious consideration.
Retrospective tax provisions: It has been very comforting to investors, hearing you reiterate time and again that this government is committed to providing tax certainty and stability and is opposed, in principle, to retrospective taxation. There are at least two prominent retrospective provisions in the Budget 2012 which clearly need to be pulled back. One relates to taxation of indirect transfers which continues to plague all purchase and sale transactions with tremendous uncertainty and unnecessary documentation to “protect” against an unclear future tax liability. You need to make this provision prospective and also clarify the meaning of “substantial interest” in Indian assets and “proportionate taxation” thereon, on the lines recommended by the Shome Committee as well as the Standing Committee on Finance. This is particularly so as you have yourself noted that Revenue has not earned a single rupee in tax from this provision. The second one providing for a retrospective change in the definition of “royalties” to include within its sweep all kinds of software- and telecommunications-related payments has led to a higher cost for Indian companies making these kinds of payments to non-residents in certain cases and needs to be amended prospectively.
General anti-avoidance rules (GAAR): While the principles behind this legislation are well known, you should consider whether India is ready for implementing these rules with effect from April 1, 2015. As you are well aware, the overall investment climate is turning positive and a provision like GAAR is bound to lead to uncertainty due to varying interpretations. For plugging specific loopholes, special anti-avoidance provisions (SAAR) have been quite effective and better-placed to achieve the desired objectives. If the objective, for example, is to restrict the use of tax treaties by entities not resident in the treaty countries, it would be much better to negotiate a “Limitation of Benefits” provision in these treaties.
Voluntary settlement scheme (VSS): You should consider introducing a VSS wherein a taxpayer is given rebate in tax liability (including waiver of interest and penalty) for withdrawal of pending appeals upto the Tax Tribunals. This will serve to unlock huge amounts locked up in uncollected taxes besides tremendously reducing the burden on appellate authorities. In tandem with the measures on strengthening the alternative dispute resolution mechanisms, this step will go a long way in reducing the number of disputes taken to the courts for resolution.
Fund management activities in India: Your last Budget had a welcome clarification that such activities would create a taxable presence for an offshore Foreign Institutional Investor (FII). This needs to be extended to any registered Offshore Fund (including FPI) to attract fund managers currently flocking to jurisdictions like Singapore and Dubai. It may be noted that this will not result in any loss of revenue to the government, rather will result in tremendous incremental benefits—including taxes on the accretion in jobs and ancillary activities.
Pass-through status for all alternative investment funds: Currently, this is made available to only investments in “Venture Capital Undertakings” (VCUs). A pass-through tax status granted to SEBI registered AIFs would put India on a par with other countries where the tax pass-through is automatically available to all collective investment vehicles. This too is an entirely revenue-neutral move but sorely needed to remove uncertainty of tax treatment.
This well-intended product has not taken off primarily due to lack of certain tax clarifications though your last Budget made a good start in this regard. Long-term capital gains on sale of units in REITs by sponsors should be treated on a par with shares in listed companies. There is also a need to extend dividend distribution tax (DDT) exemption to REITs to make them more effective.
Corporate tax: As you are aware, several expert committees have recommended removal of unnecessary profit-linked exemptions which only serve to distort the investment decisions towards tax incentives rather than business considerations. It would be much better if you choose to remove, once and for all, the insidious surcharges which have practically become part of the tax-rate, effectively driving up the corporate tax rate to nearly 34%.
Dividend distribution tax (DDT): If one takes into account the DDT applicable on distributed profits, the effective tax rate for investors in a single-layer-holding is 44% as the relief from multiple levy of DDT is only limited to subsidiaries. You should consider recognising DDT paid by the company as tax liability deemed to have been borne by the shareholders while applying disallowance under section 14A to mitigate the tax burden on investors. Further, this treatment will mean that foreign shareholders will be entitled to claim credit in their home countries for the DDT paid in India without any extra burden on Indian Revenue.
Inverted duty structure correction: You are undoubtedly aware that across large segments of products, import duties are lower than on critical raw materials required for domestic production of these items. This incentivises imports and goes directly against the mantra of Make-in-India promoted by this government. You must correct these anomalies in your forthcoming budget.
Tax administration reforms: We are given to understand that internal committees have been constituted by the CBDT and the CBEC to study the recommendations of the Shome Committee report on tax reforms. As you are aware, this committee was set up in response to the crying need for effective reforms in tax administration to enable a better business climate in the country. Similarly, you must give due consideration to the suggestions in the TARC report for expansion of the tax-base, including additional information on banking transactions beyond the prescribed material thresholds to enable the tax administration to track tax-evaders more effectively. Accordingly, you must make a policy statement on the way forward on these recommendations with a clear roadmap for implementation.
I am very conscious that yours is an unenviable task at hand and you have our full support and understanding as you go about trying to meet the already heightened expectations riding on your budget this month.
I wish you all the very best!
The author is national tax leader, EY India