Indian Banks Association (IBA) has made out a case to the government for tax incentives for trusts set up by asset reconstruction companies (ARCs) and for banks contributing to the initial capital of securitisation companies to speed up recovery of bad loans.

In its pre-budget wish list, IBA has made out a case for granting a tax exemption to the entire income of trusts set up by ARCs. Such an exemption under a provision in the Income Tax Act known as Section 10 (23) D is available to mutual funds as they are in the nature of a pass-through.

A similar tax exemption for trusts set up by ARCs has now been sought by banks. The existing income tax legislation does not recognise the pass-through nature of these trusts set up for acquisition, management and resolution of NPAs in accordance with the SARFESI Act and the RBI guidelines. The income of these trusts is taxed, although their structure is somewhat similar to that of mutual funds.

According to IBA, asset reconstruction companies (ARCs) could play a key role in creating value to impaired assets of banks and FIs by helping faster recovery of NPAs in the banking system. The magnitude of NPAs in the system makes it difficult for ARCs to fund purchase of impaired assets through debt and equity routes.

Raising funds through the issue of security receipts is a logical option. So far, ARCs have bought out bad loans from banks estimated at over Rs 20,000 crore of which they have been able to recover over Rs 2,000 crore.

Trusts are set up by ARCs as special purpose vehicles to acquire assets. A tax exemption will help in evolution of an efficient set up for NPA resolution in the country, IBA said. Security receipts issued by trusts are also similar to mutual fund units they represent the beneficial interest in the underlying assets held by the trusts.

The banking industry has sought exemption on TDS to trusts set up by the securitisation company. An exemption from TDS, again, is available to mutual funds since they are a pass-through.

Only the income accruing to the unit holder is directly taxed as investment income or capital gains when at the time of redemption. The same principle should apply to trusts set up by securitisation and reconstruction companies, according to IBA.

It has also said that the capital contribution made by banks towards initial capital of the securitisation company should be treated as business expenditure. ARCs help banks clean up balance sheets by taking over their stressed assets. RBI has stipulated a capital base of Rs 100 crore to set up an ARC.

The initial contribution made by banks should be allowed as an income tax deduction. This will provide an incentive to banks for to contribute towards setting up more ARCs, IBA said.

As on now, only two ARCs are fully functional ICICI-promoted Arcil and UTI-promoted Asrec, but many entities such as Reliance Capital and accounting firm Dhir and Dhir has shown interest in this business. Moreover, IFCI-promoted ARC, which is in talks with Cargil Fund for joint venture, has a licence to operate.