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New investment paradigm: Tax sops will no longer be the driving force for capex
November, 21st 2015

Finance minister Arun Jaitley has done well to put out his plan to phase out corporate exemptions and deductions well before the next budget since this will give investors, both in India and overseas, time to come to terms with the new reality

Finance minister Arun Jaitley has done well to put out his plan to phase out corporate exemptions and deductions well before the next budget since this will give investors, both in India and overseas, time to come to terms with the new reality – in his budget, Jaitley had announced that the reduction in the corporate tax rate from 30% to 25% over the next four years would be done in tandem with corresponding phasing out of exemptions and deductions. While this will remove uncertainty and confusion over the government plan, prior consultations with the industry is a good idea as good tax law is about certainty and not taking taxpayers by surprise. Under the plan, all profit- and investment-linked or area-based deductions will be phased out for both corporate and non-corporate tax payers.

The Central Board of Direct Taxes (CBDT) has also clarified correctly that the provisions having a sunset date will not be touched and there will be no alteration to either advance or postpone the sunset date. The weighted deductions on capital expenditure – available to the businesses like laying and operating petroleum product pipelines, constructing hotels, warehousing facilities and even affordable housing – will also end from April 1, 2017; deductions for even areas like scientific research will be curtailed.

In other words, all fresh investment that will be made in India will now have to be made on the basis of the inherent strength of the project – the size of the domestic market or advantages of manufacturing here and exporting – and could, perhaps, be boosted by some sops offered by state governments. This is a bold gamble since removing the exemptions – as high as Rs 62,400 crore in FY15 – could make many capital-intensive projects look unviable. Indeed, many of the big-ticket investments planned by governments in the past, such as special economic zones (SEZs) and national investment manufacturing zones (NIMZs) which are even bigger, or low-cost housing have been predicated on large tax concessions.

The gamble, however, may turn out to be a winning one since, in the past, surveys have shown that several firms that have come into the country came in because of India’s inherent advantages, and were happy to get the tax advantages, but these were not the deal-clinchers. Indeed, not having investment sops will also make negotiating the tax regime a lot simpler, and long-term investors should look upon that as a positive. Indeed, removing the tax sops is also recognition of the fact that India has a lot more advantages that it did not have before. In the past, even if tax sops were given, few firms would want to, for instance, manufacture mobile phones in India – but now that there is a market of nearly a billion phones already, the lure of the replacement market is huge; and skilled and low-cost labour makes exports an option. In the case of the automobile sector, similarly, as Suzuki first showed, there were important cost savings to be made by manufacturing here and exporting. In the defence industry, similarly, it is the allure of the huge domestic market that will drive investment, not the tax sops. While many corporates will argue that the moves could result in a loss of investment, the finance minister will do well to stay the course.

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