With an agenda to boost the manufacturing sector, the Prime Minister has appealed to companies around the world to “come and make in India.” Various reforms are being looked at by the government in order to make this vision come true—reforms in labour laws, special economic zone policy, trade policy, foreign direct investment rules, GST, land acquisition law and so on. However, no one seems to be talking about direct tax reforms.
In fact, some of the biggest tax disputes of the country relate to foreign investors. Disputes on indirect transfers and issue of shares have had gigantic proportions. Similarly, disputes on transfer pricing do not seem to wane away. Though the taxpayer has been granted relief at the higher appellate levels, it has created a negative adversarial image of the government. Would someone risk a big-ticket investment when such direct tax risks emanate in India. Foreign investors have been quite scared in terms of stability in the direct tax policy of the government.
The silver lining, however, is that the government has taken some steps in Budget 2014 that have erased some of the negative perceptions about the Indian tax system. Such steps include introduction of roll-back provision in the advance pricing agreement (APA) scheme, amendments in some litigative aspects of transfer pricing, tax holiday for power generating units and so on. The finance minister in his Budget speech said the government is committed to provide a stable and predictable taxation regime that would be investor-friendly and would spur growth. This would help rebuild the investor confidence to an extent.
In order to boost manufacturing, the government also extended 15% investment allowance for investment of over R25 crore in new plant and machinery in a year, as against the threshold of R100 crore earlier. The move is likely to benefit small and medium scale manufacturers.
Exports by units located in SEZs also enjoy 100% tax holiday for five years and 50% for the next 10 years, subject to redeployment of profits for the last five years. However, is this enough to make India an attractive destination for setting up manufacturing hubs? From India’s perspective, it would be a great achievement, but from the perspective of the foreign investors it may not be enough; more so when other countries are providing a host of tax incentives to the global players for investment into their respective countries. Some of these are tailor-made to the requirement of the global companies and may vary based on the size of the investment and their contribution to the economic development of the respective country.
Hence, if India has to garner a bigger slice of investment in the manufacturing sector, it needs to make changes to its direct tax laws. The government, in fact, can consider undertaking the following measures on the direct tax front.
*100% tax holiday for a period of five years, 10 years or 15 years based on the size of the new investment being made by the company. *Tax holiday should be granted in respect of export profits.
*Tax holiday should be for all types of products.
*Manufacturing facility can be located anywhere in the country so as to avail of tax holiday incentives. *Provide for complete exemption from paying MAT.
*Withholding tax exemption can be granted to all lenders in respect of foreign currency loans.
*Transfer pricing adjustment during audit proceedings should be eligible for tax holiday.
*Fast-tracking of advance pricing agreements in such cases.
*New proposals being recommended in a recent report by TARC such as the levy of fringe benefit tax and cash transaction tax should not be applied to such units. The concept of complete tax holiday schemes is not new to our tax regime. In the past, various tax holiday schemes were existing in relation to export earnings (such as 80HHC, 10A and 10B) and also in relation to development of a particular location or area ( such as 80IA and 80IB).
Most of the tax holiday schemes were withdrawn in late 2000s on account of being misused by certain companies. It was alleged that instead of the creating new capacities, the companies shut down their existing facilities and migrated production towards units eligible for tax holiday.
Now is the time to table similar benefits again in order to lift the manufacturing sector. So as to plug the loopholes in the scheme of provisions, the government can exercise smarter controls by imposing strict eligibility conditions for getting the tax holiday. The government could also consider a prior approval mechanism. The approval committee should have members of the ministry of finance, ministry of commerce & industry, ministry of labour & employment, and respective ministries for specific industries. Also, robust annual or periodic reporting systems could be put in place in order to check misuse. However, audit of all such cases could be done away with unless there is a suspicion of misuse.
It is correct that the government is under a lot of pressure to meet its direct tax collection targets and fiscal deficit is getting out of control, and hence one would argue that exemptions would further erode the base for tax collection. But we believe new investment will propel growth and employment in the country, thereby resulting in collection of other kinds of taxes which could neutralise any loss to the exchequer. Even though it will not wholly neutralise the effect of loss of collection of corporate taxes, we believe that is the cost that the government should be prepared to incur. It is not that our tax laws don’t have tax incentives, they exist but on an overall basis considering MAT and various transfer pricing related disputes have acted as a deterrent for an investor to set up a manufacturing base in India for exports.
What is being recommended above is in contrast to the stand being taken over the last 10 years when the government moved away from profit-linked to investment-linked incentives, but in our view tax incentive scheme designed to address the manufacturing sector for exports will go a long way in helping the government realise its vision of making India a manufacturing destination of choice for foreign investors. With the government in majority, it is a golden opportunity to emerge from the shadow of the country’s service sector and seize more of the global manufacturing market.