Phased reduction of the corporate tax rate and steps to tackle inverted duty structure will help industry compete globally
The finance minister has strategised growth on four platforms. One, open up large, new projects from railways, defence, roads, power and industrial corridor related activities. Two, support new and those currently stalled infrastructure projects by equity funds from the National Investment and Infrastructure Fund (NIIF) and the modified business trusts for infra and real estate. Three, facilitate Alternate Investment Funds (category I and II) for medium and large manufacturing and the new MSME Credit Fund and Credit Guarantee Fund for the bottom of the pyramid businesses which are also high employment generators. Four, fiscal consolidation and closer cooperation with RBI to assure a softer inflation and interest rate regime. The demand for manufactured goods is expected to rise from the projected economy growth rate of 8.1% and agricultural growth rate of 4%. Focus on agricultural productivity and irrigation would lead to supply-side management.
The Finance Bill has taken steps to enhance competitiveness of Indian industry by improving inverted customs duty structure on material and parts imports for making Indian finished products competitive; by announcing a phased reduction of corporate tax rate from 30% to 25% to attract foreign investments; and by reducing taxes on royalty and technical know-how fee from 25% to 10% to promote technology input. The finance minister should also announce a similar tax rate reduction for limited liability partnerships, firms and for individuals. It is hoped that 25% will be all-inclusive of surcharge, cess, etc, as 25% is still higher than the rates in Southeast Asian countries.
To achieve stability of tax law, the finance minister has also announced welcome withdrawal of the direct taxes code (DTC), and the postponement of the General Anti-Avoidance Rule (GAAR) by two years and to apply only prospectively to transactions beyond the commencement date. For domestic transactions, the transfer pricing rules will apply to transactions above R20 crore (currently R5 crore).
To facilitate fund raising, the government has removed complications in category I and II Alternative Investment Funds so as to promote them as collective investment vehicles where all income (except profits of business) will get a pass-through to the hands of the investor and will be taxed as if the investments are made directly by him. Therefore, an investor from Mauritius or another foreign country will get the advantage of the Double Taxation Avoidance Agreement (DTAA). The fund will deduct TDS at 10%. Any loss in the fund will be carried forward for adjustment next year in the fund. No dividend tax will apply on distribution and no TDS will apply to the fund on receiving income. Domestic institutions and high net worth individuals will certainly be encouraged to invest substantial funds in the Alternative Investment Funds I and II.
The NIIF will help stalled infrastructure projects, but its operationalisation speed will be essential, together with a professional management approach. Professional achievers among banks such as SBI, IDFC, Bank of Baroda, ICICI, etc, with solid infrastructure experience should be encouraged to contribute capital, board members and senior staff to make this fund a success.
A similar Development Financing Institution for manufacturing is also needed both for direct financing and take-out financing for large investment projects. RBI should evaluate this.
Many infrastructure projects (including power) have been languishing for raw materials, land or regulatory clearances. It is in the national interest to have, inter alia, tax framework that facilitates change of promoters. Most of these are initially closely held by investments from promoters and private equity (PE) funds and are not listed on the stock exchange until at a later stage. Section 79 of the IT Act 1961 does not allow their losses to be carried forward if there is a change of 51% shareholding. The same is the situation for any manufacturing company. This law should be deleted or exemption should be carved out for infrastructure and manufacturing companies. Similarly, a tax holiday should be allowed to continue even if there is a sale or merger or demerger by amending Section 80 (IA). Currently, all tax benefits are lost in any merger or demerger of an infrastructure company.
These amendments to Section 79 and Section 80 (IA) will reduce the cost of revival of these plants, and encourage efficient managements to take them over and help banks to recover their money. Otherwise, the new management has to earn profits, pay taxes and meet past liability without adjusting past losses.
Exemption from Section 56 (2) is also needed to encourage investments by angel investors registered with SEBI in start-ups as valuations in any start-up can always be questioned by tax officers. It will also stop migration of such companies to foreign centres, and promote entrepreneurship and growth.
A worrying factor is that the revised estimate for revenue growth in 2014-15 is 9.9%, while the budget estimate for 2015-16 projects 15.8%. Nominal income is estimated to grow around 11.5%. High tax buoyancy of 1.37 will have to be achieved. A very tall order, indeed. Does one foresee a harsh drive for tax collection? On top is the threat of tax evasion and black money law which will have huge penalties and imprisonment. These are not good signals. A fall in tax rates for individuals would have generated a climate of compliance and higher revenue, as with P Chidambaram’s Dream Budget.
By K S Mehta
The author is managing partner of SS Kothari Mehta & Co